Euro zone bond yields rise on trade deal expectations, fading ECB rate cut bets
Two EU diplomats said late on Wednesday that the 27-member bloc was heading towards an agreement that would result in broad 15% tariffs on its exports to the U.S., avoiding a harsher levy of 30% scheduled to be implemented from August 1.
The U.S. later called the talk of a trade deal with Europe "speculation", but markets still believed a deal was on the horizon before next week's deadline.
"Bunds dropped like a hot potato ... with risk sentiment turning for the better on 15% tariff headlines for EU goods," Commerzbank rates strategist Hauke Siemssen said in a note.
Germany's 10-year yield, the benchmark for the euro zone, rose as high as 2.684%. It was last up 7 basis points (bps) to 2.667%, on track for its biggest one-day rise since May 12. Bond yields move inversely with prices.
Germany's two-year yield, more sensitive to changes in interest rate expectations, rose 6 bps to 1.854%.
Later on Thursday, the ECB is expected to hold the deposit rate steady following 200 bps of rate cuts since the middle of last year, as the central bank waits for the fog over trade relations with the U.S. to clear.
But markets trimmed expectations for future reductions in borrowing costs after the reports of a possible EU-U.S. trade agreement.
"At the margin, it (a possible trade deal) reduces the odds for rate cuts," said Jussi Hiljanen, chief rates strategist at SEB, who expects the ECB to remain on hold today.
"Today should be a non-event. I would be surprised to see (ECB President Christine) Lagarde say something that makes the market price in more than one rate cut."
Futures now imply about a 40% chance that ECB will lower borrowing costs in September from a near 50% chance on Wednesday. Markets are pricing just 22 bps of easing by the year's end, implying an 88% chance of a quarter-point move.
Business activity in the euro zone accelerated faster than expected this month, supported by a solid improvement in the services industry and signs of a recovery in the manufacturing sector, a survey showed on Thursday.
HCOB's preliminary composite euro zone Purchasing Managers' Index, compiled by S&P Global, rose to an 11-month high of 51.0, above expectations for 50.8 in a Reuters poll of economists.
Italy's 10-year bond yield, the benchmark for the euro zone periphery, rose 6.5 bps to 3.521%.
(Reporting by Samuel Indyk; Editing by Barbara Lewis and Joe Bavier)
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