Jan 2 (Reuters) - Euro zone government bond yields rose on the first trading day of 2024, moving away from multi-month lows as money markets discounted around 160 basis points of policy rate cuts this year.
Germany's 10-year yield, the benchmark for the euro area, was last up 3 basis points (bps) at 2.061%. Last week, it hit 1.896%, its lowest level in over a year. Yields move inversely to prices.
The yield fell 55 bps in 2023 -- the biggest drop since 2014 – with almost all of the fall in November and December as inflation slowed more than expected, and the European Central Bank signalled its rate-hiking cycle was close to an end.
Bond traders mentioned outsized moves based on thin liquidity in the last weeks of December when the Bund yield dropped below 2% before reversing sharply above that threshold.
German real yields fell into negative territory at the end of December for the first time since August before hitting -0.075%, their lowest level since June 1. They were last at 0.071% on Tuesday.
"We consider negative 10y real Bund yields ambitious with aggressive ECB cuts priced in," Hauke Siemssen, rate strategist at Commerzbank, said in a note.
Bank lending across the euro zone remained weak in November, according to data from the ECB.
December 2024 forwards on the ECB euro short-term rate (ESTR) were at 2.29%, implying expectations for a depo rate at 2.39% by year-end and 161 bps of cuts from 165 bps late last week.
Germany's 2-year bond yield, which is sensitive to interest-rate expectations, was last up 5 bps at 2.452%.
TOO EARLY FOR RATE CUT?
ECB Governing Council member Robert Holzmann recently said it was too early to talk about lowering borrowing costs, and such a move in 2024 is anything but certain, while policymaker Isabel Schnabel said the ECB has a way to go before bringing inflation down to its 2% goal.
Commerzbank's Siemssen said supply implications could put bond prices under pressure this week.
"A busy and duration-intensive syndication pipeline seems ahead with euro area government bonds auction volumes picking up again," he said.
Italy's 10-year government bond yield, the benchmark for the euro area's periphery, was little changed at 3.713% after rising earlier in the session before falling back. Last week, it hit 3.468%, its lowest level since August 2022.
The gap between Italian and German 10-year bond yields was at 164 bps after recently hitting a six-month low of 154.10 bps.
Investors' focus will quickly shift to euro area inflation data, with Thursday's German figures setting the tone for financial markets.
Euro area inflation is "likely to move higher in December and January driven by energy prices base effects," said Ruben Segura-Cayuela, Europe economist at BofA, who expects a drop below the 2% target by August 2024.
A slower-than-expected reduction in Pandemic Emergency Purchase Programme (PEPP) reinvestment, a European Union stability pact allowing more time to cut public debt and expectations for aggressive rate cuts, supported demand in Italian government bonds.
Full PEPP reinvestment will end on June 30 and the portfolio will be reduced by 7.5 billion euros a month until year-end.
Analysts said that 7.5 billion was quite a digestible amount, while reinvestments remain flexible, which allows the ECB to address any unwarranted stress involving BTPs. (Reporting by Stefano Rebaudo, additional reporting by Harry Robertson; Editing by Bernadette Baum, Gareth Jones and Emelia Sithole-Matarise) ;))
