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European bonds rallied on Friday, pushing yields to their lowest level in nine months, as investors focused on recent signs of an economic slowdown and shrugged off the European Central Bank's assertion that it was not considering cutting interest rates.
Yields on 10-year German federal bonds – the benchmark for the euro zone – fell 0.11 percentage points to 2.02 percent on Friday, their lowest level since March.
The moves came despite ECB President Christine Lagarde insisting on Thursday that it was too early to talk about the timing of rate cuts and that the bank “still has more work to do” in its fight against inflation. The measures also led to a rebound sparked by a more dovish message from the Federal Reserve earlier in the week.
Friday's gains, which were mirrored in other European markets, came as the euro zone economy suffered another setback after a closely watched survey showed business activity fell at its fastest rate since the pandemic in December no longer in 2020.
“Markets feel the door is open for a strong reaction to weak PMI data,” said Richard McGuire, head of rates strategy at Rabobank. “After the Fed surprised the market with a truly surprising reversal, the ECB’s efforts to roll back the recent easing of financial conditions have clearly failed.”
The HCOB Flash Eurozone Purchasing Managers' Index fell to a two-month low of 47, compared to 47.6 the previous month. The result was below the 48 readings economists had forecast in an earlier Reuters poll.
Italian 10-year government bond yields fell 0.08 percentage point to 3.73 percent, while French government bond yields fell 0.1 percentage point to 2.56 percent.
Lagarde's attempts to warn investors against aggressive bets on lower borrowing costs were in stark contrast to those of Fed Chairman Jay Powell the day before. He said the Federal Reserve's benchmark interest rate is now “likely at or near its peak for this tightening cycle,” while new forecasts from central bank officials point to 0.75 percentage points worth of cuts next year.
“The Fed's discussion of starting to cut rates in 2024 has fueled a rapid bond rally fueled by weaker economic data,” said Craig Inches, head of rates at Royal London Asset Management. He added that the resulting drop in bond yields made the European Central Bank's job of containing inflation “even more difficult.”
The moves highlight the difficulties facing the ECB as global markets react sharply to signals from the Fed, despite officials' concerns about ongoing price pressures.
“Central banks around the world still have major credibility issues,” said Mike Riddell, bond fund portfolio manager at Allianz Global Investors. “The ECB [is] They tell us that interest rates will remain high and could even rise, but the markets simply no longer believe them.”
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