In recent weeks, sovereign bond yields across the eurozone have experienced a significant downward trend, propelled by mounting market anticipation of forthcoming rate cuts by the European Central Bank (ECB) in 2024.
ADVERTISEMENTGermany's 10-year bond yield plummeted below 2.2% this week, marking its lowest point since May 2023. This substantial decline follows its earlier surge to 3%, a multi-decade high witnessed in September.
Such yield movements have also been observed in other nations as Euronews Business explores.
In France, 10-year yields have reached 2.73%, their lowest level since April 2023, while Italy's BTP yield has descended below 4%, notably down from its previous position of over 5% in October.
The trend is also reflected in shorter-dated yields, which tend to be more responsive to interest rate expectations. For example, Germany's 2-year yield has declined from 3.30% in mid-October to 2.60%. Similarly, Italy's 2-year bond yield has experienced a 100 basis point drop to 3.20% during the same period, while France's 2-year yield has shifted from 3.50% to 2.70%.
As inflationary pressures in the euro area continue to ease - with November's annual inflation rate at 2.4%, the lowest since July 2021 and well below expectations of 2.7% - and retail sales data for October indicating a slowdown, the market is preemptively betting on a significant shift in the ECB's monetary policy in 2024.
Only two months ago, money markets were predicting a 60-basis-point reduction in ECB interest rates for 2024, equivalent to two fully priced 25-basis-point cuts. However, the landscape has undergone a significant transformation, with markets currently anticipating an initial rate cut as early as March.
They are now factoring in a total reduction of 144 basis points by December 2024, with cumulative five cuts already priced into their forecasts.
Hawks in Frankfurt lose influence
Even the more hawkish voices within the ECB board now appear less convinced that monetary policy should remain tight for longer. Isabel Schnabel, a European Central Bank board member and one of the hawks on the board, recently stated that further rate hikes are "rather unlikely" after the latest inflation data, signaling a softer stance ahead.
Another well-known hawk, Joachim Nagel, President of the Deutsche Bundesbank, also acknowledges encouraging inflation trends but cautions against excessive optimism regarding rate cuts in 2024.
Carsten Brzeski, ING's Global Head of Macro Research, believes that despite the ECB's gradual shift towards dovishness, there is still a risk that the bank underestimates the pace of disinflation, similar to how it underestimated the strength and speed of surging inflation in 2021 and 2022.
Goldman Sachs, in a recent note, suggests that rate cuts may need to be anticipated, as fiscal policy becomes more restrictive and poses a drag on economic activity in 2024. The American investment bank has emphasised that Germany will need to make fiscal adjustments after a constitutional court ruling deemed a €60 billion transfer into the climate and transformation fund (KTF) unconstitutional.
ECB meeting next week: What to expect?
The ECB is scheduled to meet on Thursday, December 14th, and it is highly likely that interest rates on the main refinancing operations and the marginal lending facility, as well as the deposit facility, will remain unchanged at 4.50%, 4.75%, and 4.00%, respectively.
President Lagarde will likely acknowledge the recent favourable inflation readings while reiterating the ECB's commitment to a data-dependent approach.
Market observers will closely scrutinise the European Central Bank's quarterly economic projections for insights into the outlook on monetary policy.
In September, the ECB's staff macroeconomic projections foresaw an average inflation at 5.6% in 2023, 3.2% in 2024, and 2.1% in 2025. When excluding energy and food, core inflation was seen at5.1% in 2023, 2.9% in 2024, and 2.2% in 2025. It is likely that the estimates for 2024 and 2025 will be revised downward for both inflation measures, given the recent favorable trends.
In terms of economic growth, the ECB projected in September that the euro area economy would expand by 0.7% in 2023, 1.0% in 2024, and 1.5% in 2025.
Downward revisions for 2024 and 2025 could further solidify market expectations of multiple rate cuts in 2024, exerting additional downward pressure on sovereign bond yields in the eurozone.
