Euro zone bond yields drop after data, supply in focus

By Stefano Rebaudo

Jan 6 (Reuters) - Euro zone government bond yields fell on Tuesday after data pointed to cooling inflation and confirmed that the regional economy had lost momentum in December.

Consumer prices rose slightly less than expected in France, while running at a rate of 2.0% in Germany in December, below November's 2.6%.

HCOB's final composite Purchasing Managers' Index data showed the euro zone economy expanded at a slower pace last month, but ended 2025 with its strongest quarterly growth in more than two years.

German 10-year yields DE10YT=RR, the euro area benchmark, were down three basis points on the day at 2.843%.

"The (German data) breakdown suggests the drop was mostly driven by energy inflation but it is encouraging that services inflation, which in Germany as a whole had risen quite sharply in recent months, also seems to have eased in some states," said Franziska Palmas, senior Europe economist at Capital Economics.

"It seems pretty clear that the bar for the European Central Bank to change its policy setting is high at the moment, and on the margin, a fall in services inflation should consolidate that view," she added.

Oil prices fell on Tuesday, further easing concerns about inflation, as the market weighed the prospect of higher Venezuelan crude output following the U.S. capture of President Nicolas Maduro.

Money markets now price in virtually zero chance of an ECB rate hike by December 2026 EURESTECBM8X9=ICAP and about 24% by March 2027 EURESTECBM10X11=ICAP, compared with 10% and 30% before the data. The deposit rate is currently at 2%.

BOND ISSUANCE UNDER THE SPOTLIGHT

Bund yields climbed to 2.917% before Christmas, just a couple of basis points shy of their March highs, when Germany struck a political deal to ramp up infrastructure and defence spending.

Supply is in focus, with Citi forecasting euro area gross issuance at 200  billion euros ($233.92 billion) in January - the highest monthly amount on record - and projecting the net cash requirement (NCR) to remain elevated at 124  billion euros, only marginally below the record high of January 2025.

NCR refers to the net amount of funds euro area governments seek to raise through new bond issuance after accounting for repayments on existing debt.

German 30-year yields DE30YT=RR were down 3.2 bps at 3.48%. They reached 3.556% on December 22, their highest since July 2011, as long-dated debt prices came under pressure on expectations for heavier bond supply.

Yields on German 2-year Schatz DE2YT=RR, which are more sensitive to expectations for policy rates, also fell three bps to 2.1%.

Italian 10-year government bond yields IT10YT=RR dropped 3.8 bps to 3.494%, leaving their premium to Bund yields at 65 bps after touching 60 bps last week, the lowest since September 2008.

($1 = 0.8550 euros)