German yield curve flattens after four weeks of steepening

By Stefano Rebaudo

July 21 (Reuters) - The German yield curve flattened on Monday as investors took a breather after four weeks of steepening, while awaiting euro zone PMI data and the European Central Bank’s monetary policy decision later this week.

The curve steepened as investors shifted their focus to expansionary fiscal plans in Germany, driving long-dated yields higher while short-dated ones held steady, widening the gap between the two ends of the curve.

Markets forecast that increased fiscal spending will lead to a greater supply of government bonds, and higher yields.

Economists expect the ECB to leave rates unchanged on Thursday, before potentially cutting them in September.

The yen firmed as markets shrugged off the Japanese ruling coalition's defeat in upper house weekend elections.

Germany’s 10-year government bond yield DE10YT=RR, the euro area’s benchmark, dropped 5 bps to 2.64%.

Some analysts expect June PMIs to stagnate on Thursday, citing tariff uncertainties and a strong euro — factors that could lend support to Bund prices.

On the other side, improving economic data would allow markets to discount the impact of tariffs even further and focus on the upcoming fiscal impulses.

German 2-year government bond yields DE2YT=RR – more sensitive to expectations for European Central Bank policy rates – fell 2.5 basis points (bps) to 1.82%.

The gap between German 10-year and 2-year yields DE2DE10=RR fell 2.5 bps to 82 bps.

Money markets are fully pricing in one 25 bp ECB rate cut by December EURESTECBM4X5=ICAP, and around a 50% chance of that move coming in September EURESTECBM2X3=ICAP.

Investors are also watching tariff negotiations after the Financial Times reported on Friday that U.S. President Donald Trump is pushing for a minimum tariff of 15% to 20% in any deal with the European Union.

“I believe June marked the final (ECB) rate cut, assuming the average U.S. tariffs for Europe will be at around 10%,” said Simon Wells, chief European economist at HSBC.

“A persistent 30% tariff might not be enough to trigger a recession but, in this case, we will likely see some ECB reaction,” he added.

Euro zone firms remain optimistic about their growth prospects but are also experiencing pressure on their profits, in part due to trade tensions, an ECB survey showed on Monday.

Italy’s 10-year government bond yields IT10YT=RR were down 5 bps at 3.53%, with the spread between BTP and Bund yields - a market gauge of the risk premium investors demand to hold Italian debt - at 86.5 bps. It hit 84.20 bps in June, its lowest since March 2015.