Euro zone government bond yields edge down before central bank meetings

By Stefano Rebaudo

Oct 28 (Reuters) - Euro zone government bond yields inched lower for a second straight session on Tuesday, paring Friday's rise, as investors turned cautious ahead of central bank decisions and amid uncertainty over a broad U.S.-China trade deal.

The U.S. Federal Reserve wraps up its two-day policy meeting on Wednesday, and rate decisions from the European Central Bank and the Bank of Japan are due on Thursday.

Borrowing costs jumped on Friday after strong euro zone purchasing managers' index readings, while traders priced in slightly less than a 50% chance of another ECB rate cut next year.

Investors are now awaiting key euro area inflation data, which could influence expectations for future ECB policy moves.

Germany’s 10-year Bund yields fell 0.5 basis points (bps) to 2.61%, after dropping one basis point (bp) the previous day.

Markets have fully priced a 25 bps rate cut by the Fed on Wednesday for a while and will closely watch any clues about a possible end of quantitative tightening measures.

The BoJ is expected to consider the best timing for the next hike, while the ECB is seen keeping rates unchanged and offering no guidance on the outlook.

"The ECB cutting cycle is presumably complete, with inflation broadly at target and growth around trend, and the deposit facility rate at a level likely considered the mid-point of a neutral euro area policy range by the majority of Governing Council members," said PIMCO portfolio manager Konstantin Veit.

Money markets priced in a 54% chance of a 25 bp ECB rate cut by September EURESTECBM8X9=ICAP. The key rate is seen at about 1.90% in December 2026 EURESTECBM10X11=ICAP from the current 2%.

Euro zone consumers have lowered their inflation expectations for the next year, indicating price growth is no longer a major worry, the ECB's Consumer Expectations Survey showed.

Germany’s 2-year yields DE2YT=RR, more sensitive to expectations for ECB policy rate outlook, dropped one bp to 1.97%.

The yield gap between safe-haven Bunds and 10-year French government bonds DE10FR10=RR — a market gauge of the risk premium investors demand to hold French debt — was at 80.50. The spread hit 87.96 bps in early October, its widest since January, driven by investor concerns over France's fiscal trajectory.

“We remain negative on France,” said Mohit Kumar a European economist at Jefferies, referencing the French National Assembly's adoption of an amendment to increase corporate taxes, as a compromise to get a budget deal.

“The only way for the current government to survive is to offer more compromises which would be fiscally negative,” he added.