UPDATE 1-Euro zone bond yields edge up, inflation expectations rise – Reuters

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds comment, PMIs, inflation gauge)

LONDON, July 5 (Reuters) – Euro zone government bond yields nudged higher on Monday but analysts expect the recent downward trajectory to resume after last week’s U.S. payrolls data failed to tempt investors away from the safety of fixed income.

The German 10-year Bund yield dropped 8 basis points last week – its biggest weekly fall since December 2020.

Analysts attributed the drop in euro zone yields to caution about the economic impact of the Delta variant of COVID-19 as well as expectations that the European Central Bank will remain dovish.

“Even in a more benign Delta scenario, we now expect more restrictions on international travel, hitting the crucial tourism sector in southern Europe for a second summer,” wrote Morgan Stanley economists in a note to clients.

A survey on Monday nevertheless showed business activity in the euro zone expanded at the fastest rate in 15 years in June, as the easing of more coronavirus restrictions helped the bloc’s dominant service industry.

A measure of euro zone inflation expectations — the five-year, five-year inflation forward — rose to 1.598%, its highest since May.

Friday’s June U.S. jobs report signalled economic recovery remained intact but did not warrant any immediate withdrawal of Federal Reserve stimulus. The data had little impact on U.S. Treasury yields, which also ended the week lower.

The next test for bond markets will be the minutes of the Federal Open Markets Committee June meeting, which will be released on Wednesday. At that meeting, the Fed surprised markets by signalling two rate hikes by the end of 2023.

At 0706 GMT, Germany’s 10-year Bund yield was up by one basis point at -0.221%.

Benchmark French and Italian 10-year yields were up by 2 bps .

“The outlook for risk sentiment remains clouded by the rise in COVID-19 cases in many places in the world. Interestingly, these worries are more clearly observed in rates than in other markets,” ING rates strategists wrote in a note to clients.

“This is not unusual in times when central banks retain a heavy hand in the pricing of financial assets. The logic goes like this: a further worsening of the outlook would prompt an even slower unwind of monetary support measures.”

ING analysts said they expected to see euro zone rates skew lower over the coming days.

Commerzbank rates strategist Rainer Guntermann wrote that he expects the German 10-year yield to remain between -0.1% and -0.25% for most of the summer, and for it to move lower over the next few days.

ECB Vice President Luis De Guindos is due to speak at 1700 GMT. (Reporting by Elizabeth Howcroft; Editing by Kirsten Donovan and Catherine Evans)

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