Euro zone bond yields steady as eyes turn to ECB decision

Euro zone government bond yields were steady on Monday as traders braced for a widely expected European Central Bank rate cut later this week, while U.S. trade policy remained in focus.

Germany's 10-year yield, the benchmark for the euro zone, was last up less than 1 basis point (bp) at 2.513%, after its biggest weekly fall since mid-April last week. Bond yields move inversely to prices. The European Central Bank is tipped to cut its key rate to 2% on Thursday, its eighth move this cycle. Investors reckon a pause will then follow as the economy is holding up better than anticipated and longer-term inflation worries creep back.

Money market traders are almost fully pricing in a quarter-point move on Thursday, while about 55 basis points of easing is priced by the end of the year, implying only one more quarter point move. "They (the ECB) have had all the opportunities in the world to push back against market pricing and haven't done that," said Nordea chief analyst Anders Svendsen.

"The interesting thing will be around the new staff projections because they will factor in the fiscal package from Germany and the trade war," he added. "It will probably push up their core inflation forecast a little bit." Germany's two-year yield, which is more sensitive to changes in interest rate policy and expectations, was little changed at 1.79%, within its recent tight range.

Markets were largely unmoved after data showed U.S. and euro zone manufacturing activity contracted last month, even as the downturn in euro zone manufacturing eased slightly. The HCOB Eurozone Manufacturing Purchasing Managers' Index rose to 49.4 in May from 49.0 in April. That was a 33-month high and in line with a preliminary estimate, but below the 50.0 threshold separating growth from contraction.

Attention remains on U.S. trade policy, after President Donald Trump on Friday said he planned to increase tariffs on imported steel and aluminium to 50% from 25%, deepening his trade war. "Doubling import taxes on steel and aluminium, and aggravating China once again, mean we face a situation where uncertainty prevails," said AJ Bell investment director Russ Mould.

Traders were also cautious around a 10-year Japanese auction taking place on Tuesday, which comes following weak demand for long-dated auctions in May. Yields of government bonds across the globe with the longest maturities have risen in recent weeks, although moves in Germany have been more subdued despite Germany's spending commitments.

Germany's 30-year yield was last up 1.5 bps at 3.02%, but remains well below its year-to-date high of 3.25% from mid-March. Italy's 10-year yield, the benchmark for the euro zone periphery, was up 0.5 bps to 3.50%, keeping the closely watched gap between Italian and German 10-year bond yields steady at 96 bps.

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