Euro zone bond yields diverge, while inflation in the bloc jumps

By Sophie Kiderlin

LONDON, Oct 2 (Reuters) - A brutal selloff in European government bond markets left traders on Friday favouring safe-haven German debt over weaker countries such as France, albeit with less volatility than the previous day, while euro zone inflation jumped.

Yields had diverged sharply on Thursday, especially among shorter-dated bonds. German 2-year bond yields dropped almost 14 basis points, their biggest daily fall since April, and the Dutch 2-year yield fell around 13 bps, while French and Italian 2-year yields jumped.

German and Dutch government bonds are typically seen as safe havens, while others such as French and Italian bonds are regarded as more risky, given the size of those countries' debt burdens relative to their economies.

Government bonds around the world have been under pressure recently amid debt and fiscal concerns, high energy prices and worries about inflation.

The divergence continued on Friday, but somewhat less sharply. German 2-year bond yields were last down by 5.8 bps at 2.9962%, while French 2-year yields were around 6.7 bps higher at 3.7608%. Italian 2-year yields were down by less than 1 basis point at 3.6109%.

Rene Albrecht, analyst at DZ Bank, flagged a "flight to quality", adding that "the safe haven bid has now arrived".

Shorter-dated government bond yields are generally more sensitive to interest rate expectations.

Money markets on Thursday and Friday pared back pricing for further interest rate hikes from the ECB. A further policy increase from the central bank is now not being fully priced in by traders until early 2027.

Data on Friday showed that euro zone inflation rose by more than expected in September.

Inflation in the 21 nations sharing the euro currency jumped to 3.8% in September from 3.2% a month earlier, exceeding expectations for 3.6% in a Reuters poll, driven primarily by fuel, natural gas and, to a lesser extent, food costs.

A closely watched "core" figure, which excludes volatile food and fuel prices and signals underlying trends, accelerated to 2.5% from 2.4%.

DZ Bank's Albrecht said that the core reading showed that the underlying inflation trend was "actually quite steady and given the circumstances quite okay."

Later in the day, investors will be watching out for key data from the US, which will add to the global economic picture.

FRANCE IN FOCUS

Ten-year government bond yields also diverged again on Friday. German 10-year bond yields were last down roughly 10 bps at 3.4178%, while Italy's 10-year bond yield was around 3 bps lower at 4.6847%.

French 10-year yields were 1.5 bps higher at 4.9435%.

The spread between French and German 10-year yields – a measure of the risk premium investors demand for lending to France – soared above the 150 bps mark on Friday, hitting its widest since late 2011. It was last at around 152 bps.

French bonds have been under especially strong pressure as high debt levels and emerging political risks ahead of a 2027 presidential election have added to factors weighing on government bonds more broadly, such as expectations for higher policy rates.

France on Thursday presented its 2027 budget bill, seeking to enact unpopular belt-tightening measures to lower its deficit, but this gave markets little relief.