Euro, bond yields tumble as investors ramp up ECB rate cut bets after PMI

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Bond yields, euro tumble on weak PMIs

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Investors ramp up ECB rate cut bets

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Markets see a 50% chance of a 50 bps cut in December

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Bank stocks fall as much as 2.1%

By Stefano Rebaudo and Dhara Ranasinghe

Nov 22 (Reuters) - German short-dated government bond yields and the euro tumbled to their lowest level in around two years on Friday as markets ramped up European Central Bank rate cut bets after data showed a sharp decline in euro area business activity.

Business activity in the euro zone took a sharp turn for the worse this month as the bloc's dominant services sector contracted and manufacturing sank deeper into recession, a PMI survey showed on Friday.

France slowed at the sharpest pace since early this year, while Germany's business activity fell for a fifth month running and at the quickest rate since February.

The reaction from investors was swift as they drove euro zone government bond yields down on expectations of further ECB rate cuts. The euro briefly fell as much as 1%>.

Money market pricing suggested that investors now price a 50% chance of a 50 basis point (bps) rate cut at the ECB's December meeting, up from 20% before the data. . A 25 bps cut is fully discounted.

Traders also priced in an ECB deposit facility rate at around 1.80% in July, down from 1.95% before PMI figures.

"Markets are reacting because they think the ECB needs to do more," said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, adding that he still expects the ECB to cut by 25 bps in December.

Germany's two-year bond yields, more sensitive to expectations for the ECB policy rates, hit 1.979%, their lowest level since December 2022.

The surveys and data released on Friday will reinforce the view expressed recently by many policymakers that they are becoming more concerned about the outlook for growth than for inflation.

Bond yields were down across the euro area with Italian two-year yields 9 bps lower at 2.49%.

Bank stocks, which have benefited from higher interest rates since 2022, fell as much as 2.1% as markets moved to price in more rate cuts from the ECB after the PMI data.

The pan-continental STOXX 600 index was up 0.3% on the day as of 1038 GMT, having been 0.75% higher before the data.

Markets are also closely watching developments on the geopolitical front, as investors have bid for safe-haven government bonds.

Russia fired a hypersonic intermediate-range ballistic missile at the Ukrainian city of Dnipro on Thursday. North Korean leader Kim Jong Un has accused the United States of ramping up tension and provocations, saying the Korean peninsula has never faced a greater risk of nuclear war.

Germany's 10-year yield, the benchmark for the euro area, was down 6 bps at 2.25%, after hitting its lowest level since Oct. 21. It was up 2 bps before the data.

The gap between French and German yields - a gauge of the premium investors demand to hold France's debt - widened 3.5 bps to 79 bps on Thursday after hitting 70.9 bps last week, its tightest since Oct. 31.

French far-right leader Marine Le Pen threatened on Wednesday to topple Prime Minister Michel Barnier's fragile coalition government, slightly widening the French spread.

The yield spread between Italian and German bonds was at 126 bps after reaching 115.90 on Wednesday, its tightest since mid-March 2024, ahead of a possible upgrade by Moody's later on Friday. (Reporting by Stefano Rebaudo and Dhara Ranasinghe; additional reporting by Samuel Indyk. Editing by Elisa Martinuzzi and Susan Fenton)