Euro zone bond yields drop again ahead of ECB meeting

LONDON: Euro zone bond yields fell on Tuesday as investors cheered signs that the Federal Reserve might let up on rate hikes and that the energy crisis is easing.

German and Italian yields slid for a second consecutive session in the wake of a media report on Friday, which highlighted that Fed officials are debating whether to slow the pace of interest rate increases in December. The drop came despite traders anticipating another jumbo interest rate hike from the European Central Bank (ECB) on Thursday. The ongoing fall in natural gas prices also helped drive a rally in European markets. The continent's benchmark gas price has dropped around 70% from record highs touched earlier this year.

"The green shoots market sentiment prompted by the dovish Fed report at the end of last week still resonates," Commerzbank analysts, led by Christoph Rieger, said in a note. "Tumbling gas prices add to speculation that energy prices (and headline inflation) could fall faster next year."

Germany's 10-year government bond yield was down 8 basis points (bps) on Tuesday at 2.265%, after falling 9 bps on Monday. Yields move inversely to prices. The ECB is widely expected to raise rates by 75 basis points for the second consecutive meeting on Thursday, taking the deposit rate to 1.5%.

However, a weakening euro zone economy and signs that the Fed might slow down have boosted bets that the ECB will struggle to drastically hike interest rates in its ensuing meetings. Italy's 10-year yield fell 13 bps on Tuesday to 4.462%, its lowest since Oct. 6.

The closely watched gap between Germany and Italy's 10-year yields narrowed to 218 bps, near its lowest since the end of September. German Ifo survey data released on Tuesday showed that business sentiment stayed at a two-year low this month. Separate survey data published on Monday showed that euro zone business activity contracted at the fastest pace in nearly two years in October.

A slowing economy, along with warmer weather and efforts to fill storage facilities, has helped pull down European energy prices. Dutch TTF natural gas futures, the benchmark European price, have dropped from highs of above 340 euros ($335.21) per megawatt hour earlier this year to 95 euros on Tuesday. British 10-year yields were down 6 bps at 3.681%, the lowest since Oct. 3, as former finance minister Rishi Sunak prepared to officially become the country's new prime minister on Tuesday. ($1 = 1.0143 euros)