Euro, bond yields tumble as investors boost ECB rate cut bets after PMI data

(Updated at 1530 GMT)

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Bond yields, euro tumble on weak PMI data

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Investors ramp up European Central Bank rate cut bets

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Markets see 50% chance of 50-basis-point cut in December

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Bank stocks down as much as 2.1%

By Stefano Rebaudo, Dhara Ranasinghe

Nov 22 (Reuters) - German short-dated government bond yields and the euro tumbled to their lowest levels in around two years on Friday as markets ramped up European Central Bank interest 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% against the dollar and was last down 0.6% at $1.0417. Money market pricing suggested investors are now nearly evenly split over chances of a 50-basis-point rate cut at the ECB's December meeting, up from 20% before the data. . A 25-basis-point 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 basis points 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. The five-year, five-year forward inflation swap, a closely watched gauge of the market's long-term euro zone inflation expectations, inched closer to 2%, a level last seen in July 2022. The ECB targets inflation at 2%. Bond yields were down across the euro area, with Italian two-year yields 10 basis points lower at 2.443%.

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 1.1% on the day as of 1530 GMT.

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 U.S. 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 4 basis points at 2.28%, after hitting its lowest level since Oct. 21. It was up 2 basis points before the data. The gap between French and German yields - a gauge of the premium investors demand to hold France's debt - widened as much as 5 basis points on Friday to 79.9 basis points, up from 70.9 basis points at the end of October. 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 124.7 basis points 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, Susan Fenton and Paul Simao)