MILAN: Euro zone government bond yields dropped on Tuesday as weak economic data and falling oil prices led investors to increase their bets on future European Central Bank rate cuts.
Markets await US jobs data later in the session after economic figures showed on Monday that US manufacturing activity slowed for a second straight month in May, the latest indications that a gradual economic slowdown is taking hold.
The number of people out of work in Germany rose more than expected in May, data showed on Tuesday.
Oil prices eased as much as 1 per cent in Asian trade, extending losses from the previous session.
Germany's 10-year yield, the bloc's benchmark, was down 5 basis points (bps) at 2.54 per cent, after dropping 6.5 bps the day before in its biggest daily fall since May 15.
"With just 35 bps discounted until year-end after this week's prospective ECB rate cut and falling oil prices reviving disinflation hopes, the momentum looks set to continue," said Christoph Rieger, head of rates strategy at Commerzbank.
Investors are taking an ECB rate cut of 25 bps for granted on Thursday but are uncertain about the outlook.
Money markets are pricing in 63 bps of ECB monetary easing in 2024 - from less than 55 bps early on Monday - which implies two rate cuts and slightly more than a 50 per cent chance of a third move by year-end.
"Yet it seems markets are strongly driven by US data when deciding on the number of ECB cuts to expect this year," rate strategists at ING said, after flagging that the correlation between US Treasury and Bund yields is increasing again.
The spread between US and German 10-year yields - a gauge of expectations for monetary policy divergence between the US Federal Reserve and the ECB - hit a fresh 2-1/2-month low at 180.01 bps and was last at 183.8 bps, 3 bps wider from the day before.
The gap between French and German 10-year government bond yields was still around 48 bps after Standard & Poor's cut its rating on France's sovereign debt late Friday, a move that market participants had widely expected.
Italy's 10-year yield fell 4 bps to 4.015 per cent after dropping 9 bps, its biggest daily drop since May 15.
"BTPs remain overall resilient though, defying more fundamental headwinds as the manufacturing PMI kept falling, taking the difference to Spain to a record high," Commerzbank's Rieger added.
Manufacturing activity contracted in Italy at the steepest pace this year, and grew at the fastest pace in more than two years in Spain.
The yield gap between Italian and German bonds , a gauge of the risk premium investors seek to hold Italian bonds, was at 130 bps.
Germany's 2-year government bond yield, more sensitive to policy rate expectations, was down 3 bps at 3.00 per cent. — Reuters
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