Bund yields drop to lowest since early February as investors focus on rate cuts

Euro area benchmark Bund yields dropped on Thursday to their lowest since early February as investors focused on central bank policy easing amid weak economic data from both sides of the Atlantic.

Bund yields were also on track for their fourth straight weekly fall, and the biggest since mid-June.

A measure of US manufacturing activity dropped to an eight-month low in July amid a slump in new orders, triggering a sharp fall in US Treasury yields.

The Bank of England cut rates from a 16-year high after a narrow vote in which policymakers were divided over whether inflation pressures had eased sufficiently.

Federal Reserve Chair Jerome Powell said on Wednesday interest rates could be cut as soon as September if the US economy follows its expected path.

The euro area's borrowing costs showed a muted reaction to the BoE decision, which most analysts expected.

Germany's 10-year yield, the benchmark for the euro zone bloc, hit its lowest since early February at 2.232 per cent after the US data and was last down 6 bps at 2.24 per cent.

It was heading for a sixth straight day of declines, having ended July with a drop of 18 bps, and about to close the week 16 bps lower.

"The outlook (for Fed monetary policy) remains uncertain, with the US presidential election and resulting political policy shifts adding to the uncertainty," said economists at PIMCO, adding the economic backdrop will probably lead the Fed to cut rates several times, starting in September.

The spread between US 10-year Treasuries and German Bunds tightened 1.5 bps to 173 bps.

Markets are pricing two European Central Bank 25 bps rate cuts and an almost 40 per cent chance of a third move in 2024. They were discounting an around 75 per cent chance of 50 bps by year-end less than a couple of weeks ago.

The German economy unexpectedly contracted in the second quarter while inflation ticked higher.

Economies grew in Italy, France and Spain, but euro zone activity declined in July at its fastest pace this year.

Italian 10-year government bond yields fell one bp to 3.64 per cent, leaving their premium over Bunds 4 bps wider at 139 bps.

France and Spain came to market with a long-term bond auction.

The gap between French and German yields - a gauge of the risk premium investors demand to hold French government bonds - hit the highest since last month's French elections at 74.50 bps.

It has widened recently as markets worry the parliament could reverse President Emmanuel Macron's pension reform, increasing public spending.

Money markets are pricing a 20 per cent chance of another BoE rate cut in September while fully discounting such a move in November.

"It was still a meeting by meeting, data dependent forward guidance," said James Lynch, fixed income investment manager at Aegon Asset Management with reference to the BoE.

"This means we would not expect a cut at the next meeting in September but in November which the market has already fully discounted," he added.

British 10-year Gilt yields dropped 10 bps to 3.87 per cent, while 2-year yields fell 12 bps to 3.69 per cent.