German bond yields hit four-month highs, bets wane on ECB cuts

German 10-year government bond yields hit their highest in four months on Friday, as fading conviction among investors for steeper rate cuts from the European Central Bank compounded a push out of safe havens on optimism over U.S.-EU trade talks. The ECB left interest rates at 2% on Thursday, as expected, and President Christine Lagarde suggested policymakers were less concerned than before about an abrupt slowdown in growth and inflation over the coming year. Bond yields rose sharply in response.

Meanwhile, optimism is growing that the European Union will be able to secure an agreement with the United States on trade at a lower tariff than the 30% threatened by President Donald Trump if there is no deal by his August 1 deadline. Trump said on Friday there was a "50/50 chance" of reaching a deal with the EU in time.

Two-year German Schatz yields, which rose by nearly 12 basis points on Thursday in their biggest one-day increase since mid-May, were up 2 bps at 1.931%, around their highest since April 3, the day after Trump's "Liberation Day" announcement on tariffs. Benchmark 10-year German yields retreated from the day's high of 2.768%, the highest since late March, to trade 3 bps higher on the day at 2.726%.

Italian yields followed suit, up 3 bps on the day at 3.591%. Two sources told Reuters on Thursday that ECB policymakers were setting the bar high for a September rate cut and would need to see a significant deterioration in growth and inflation before backing further easing.

BRIGHTER OUTLOOK Recent economic data suggests the euro zone is weathering uncertainty over U.S. tariffs reasonably well.

Euro zone business activity hit an 11-month high in early July, based on HCOB's preliminary composite euro zone Purchasing Managers' Index, compiled by S&P Global on Thursday. "After good PMI numbers and a positive tone from the ECB, the path towards higher rates is becoming even clearer. If a trade deal gets signed, we should see rates move up further, with the 10-year swap rate hitting at least 2.8%," ING rates strategist Michiel Tukker said.

The 10-year swap rate, an indicator of long-term borrowing costs, is hovering around 2.7%, its highest since March, having risen by nearly 20 bps in the last month. Tukker said a move towards 3% would likely be slower and would depend on growth remaining resilient.

Money markets show traders are undecided about another ECB rate cut this year, attaching about a 30% chance of a drop below 2% by the end of December. Reflecting some of that greater confidence in the outlook was a modest improvement in German business morale in July. A survey on Friday from the Ifo institute showed its business climate index rose to 88.6 this month - the highest in 13 months - from 88.4 in June, slightly below a Reuters forecast for 89.0.

A separate report from the ECB showed bank lending in the euro zone grew at the fastest pace in two years last month, extending a gradual recovery fuelled by lower borrowing costs and a stabilisation in the economy.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)