German yields edge down as markets focus on US data, ECB meeting

German government bond yields fell on Monday as investors' focus shifted to key U.S data and a policy meeting of the European Central Bank later this week.

Euro area borrowing costs lost ground recently as economic figures showed a bleak outlook and market inflation expectations dropped to below 2%.

Germany's 10-year yield (DE10YT=RR), the benchmark for the euro area, was down 0.5 basis points (bps) to 2.11%. It recorded on Friday its first weekly rise in more than a month, with an increase of 6 bps.

Most analysts expect a 25 bps ECB rate cut on Thursday and will focus on the communication, which could provide clues about the ECB's future moves.

"They (the ECB) could remove the reference to the Governing Council keeping policy rates 'sufficiently restrictive', thus suggesting that the path towards neutral rates has now been cleared," said Reinhard Cluse, chief European economist at UBS.

The neutral rate – which many analysts see at around 2% - is the theoretical interest rate that would keep the economy operating at full employment and stable inflation.

"In the press conference, President (Christine) Lagarde might also say that the ECB is broadly on track to returning inflation back to the target," he added.

Money markets priced in a depo rate of 1.87% in July (EURESTECBM6X7=ICAP), down from the current 3.25%, while fully discounting a 25 bps rate cut in December (EURESTECBM1X2=ICAP) and almost no chance of a 50 bps move.

U.S. inflation data on Wednesday may affect expectations for the Federal Reserve's monetary easing path.

Investors are now pricing in an 87% chance of a 25 bps Fed cut, in line with the levels seen on Friday after U.S. figures, according to the CME's FedWatch Tool.

The gap between French and German yields (DE10FR10=RR) – a gauge of the risk premium investors demand to hold French debt – fell 0.5 bps to 76 bps while investors closely watched political developments in France after the fall of Prime Minister Michel Barnier's government.

It hit 72.40 bps on Friday, its lowest since Nov. 21, as hopes grew that France may end up with a 2025 budget approved by parliament, while the prospect of European Union joint funding fuelled broader convergence among bond yields.

"Doubts on the sustainability of the euro construct could resurface," said Raphael Gallardo, chief economist at Carmignac, referring to the political crisis in France.

"France cannot deflate its debt or devalue its currency. The pain of the fiscal adjustment will be felt in the real economy, notably on the labour market," he added.

Italy's 10-year government bond yields IT10Y – the benchmark for the euro area periphery – dropped one bp to 3.19%. The BTP yield spread (DE10IT10=RR) was last roughly unchanged at 108 bps, after briefly hitting a fresh 37-month low early this morning at 104.5 bps.