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European bonds rallied on Friday, pushing yields to nine-month lows as investors focused on the latest signs of a slowing economy and shrugged off the European Central Bank’s insistence that it was not considering interest rate cuts.
The yields on 10-year German Bunds — the benchmark for the eurozone — dropped by 0.11 percentage points on Friday to 2.02 per cent, the lowest level since March.
The moves came despite ECB president Christine Lagarde’s insistence on Thursday that it was too soon to talk about the timing of rate cuts and that the bank had “more work to be done” in its battle to tame inflation. The moves also extended a rally sparked by a more dovish message from the US Federal Reserve earlier in the week.
Friday’s gains, mirrored across other European markets, came as the eurozone economy suffered another setback after a closely watched survey showed business activity had declined in December at the fastest pace since the pandemic hit in 2020.
“The markets feel the door is open in terms of reacting strongly to weak PMI data,” said Richard McGuire, head of rates strategy at Rabobank. “After the Fed blindsided the market with a really quite surprising pivot, the ECB’s efforts to roll back the recent easing of financial conditions has clearly fallen flat.”
The HCOB flash eurozone composite purchasing managers’ index fell to a two-month low of 47, down from 47.6 a month earlier. The result was lower than the 48 reading forecast by economists in an earlier Reuters poll.
Yields on 10-year Italian debt fell 0.08 percentage points to 3.73 per cent, while French government bond yields fell 0.1 percentage points to 2.56 per cent.
Lagarde’s attempts to warn investors against aggressive bets on lower borrowing costs were in stark contrast to Fed chair Jay Powell the previous day. He said the US Fed’s benchmark rate was now “likely at or near its peak for this tightening cycle”, alongside new forecasts from central bank officials pointing to 0.75 percentage points worth of cuts next year.
“The discussion by the Fed to begin cutting rates in 2024 poured fuel on a raging bond rally that was sparked by weaker economic data,” said Craig Inches, head of rates at Royal London Asset Management. He added that the resultant fall in bond yields made the European Central Bank’s job of containing inflation “even harder”.
The moves highlight the difficulty that the ECB faces as global markets react forcefully to signals from the Fed, despite officials’ concerns about persistent price pressures.
“Central banks everywhere are still really struggling with credibility,” said Mike Riddell, a bond fund portfolio manager at Allianz Global Investors. “The ECB [is] telling us that rates will stay high and could even go higher, but markets simply don’t believe them any more.”
