German 2-year Bund yield drops 5 bps as rate-cut bets intensify

The German two-year Bund yield slid 5.2 basis points to 2.763% on Thursday, the biggest daily drop since early July, as weaker-than-expected growth data reinforced expectations for additional ECB monetary easing before year-end.

"The market is pricing in a higher probability of a September cut after the GDP print confirmed the recovery remains fragile," said James Rossiter, head of global macro strategy at TD Securities. "The risk is now skewed toward a more aggressive easing cycle."

The move steepened the curve, with the two- to 10-year yield spread widening 4.5 basis points to 38.9 basis points — the widest in two weeks. The 10-year Bund yield slipped 0.7 basis point to 3.154%, while the 30-year yield rose 2.6 basis points to 3.658%. Across the euro area, French 10-year yields fell 2.1 basis points to 3.940%, Italian yields dropped 2.7 basis points to 3.963%, and Spanish yields declined 2 basis points to 3.601%. Greek 10-year yields also fell, declining 3.1 basis points to 3.860%.

The repricing comes as Germany's economy expanded just 0.2% in the second quarter, preliminary data showed, highlighting the challenge facing the ECB as it balances taming inflation with supporting a stagnant regional economy. Money markets now price around 50 basis points of additional ECB easing through year-end, up from about 35 basis points before the GDP release.

The selloff in short-dated German debt accelerated after European afternoon trading, with the two-year yield reversing an earlier rise to hit a session low of 2.763%. The yield had opened higher at 2.861% before the GDP data shifted sentiment, marking an intraday swing of nearly 10 basis points.

The curve steepening reflects a classic bull-steepening pattern, where short-end yields fall faster than long-end yields as traders price in near-term rate cuts while longer-term growth and inflation expectations remain relatively stable. The 30-year Bund yield's modest rise to 3.658% suggests investors are demanding a higher term premium as they weigh elevated government debt levels across the bloc. The last time the two-year yield fell this sharply in a single session was in early July, following weaker industrial production data that showed factory output contracting for a third consecutive month.

The euro weakened against the dollar after the GDP data, falling 0.3% to $1.0850 as lower rate expectations reduced the yield advantage of euro-denominated assets. The Euro Stoxx 50 index edged 0.2% higher, with rate-sensitive utility and real estate stocks leading gains.

The bond moves also come as fiscal debates intensify across Europe. German Chancellor Friedrich Merz this week traveled to Dublin to press for deep cuts to the European Union's next seven-year budget, arguing the current 1.7 trillion euro proposal is unacceptable. High government debt across the region continues to complicate efforts to create a common European safe asset, according to a recent analysis by The Economist.

Peripheral spreads — the premium investors demand to hold Italian and Spanish debt over German bunds — narrowed slightly, with the Italy-Germany spread tightening to about 81 basis points from 83 basis points, suggesting rate-cut expectations are outweighing fiscal concerns for now.

For the ECB, the combination of tepid growth and political pressure for fiscal restraint creates a delicate policy calculus. The central bank's deposit rate, cut by 25 basis points in June, stands at 2.50%, and the next policy decision is scheduled for September 12. If growth data continues to disappoint, pressure will mount for a follow-up cut — potentially of 25 or even 50 basis points.

This article is for informational purposes only and does not constitute investment advice.