Euro zone yields near lows as China slowdown puts trade war in focus

LONDON: High-grade euro zone bond yields hovered near recent lows on Monday as softening Chinese growth kept investors wary about the potential global economic impact of a trade dispute between the United States and other major countries.

China's economy expanded at a slower pace in the second quarter as Beijing's efforts to contain debt crimped activity, while June factory output growth weakened to a two-year low in a worrying sign for investment and exporters as a trade war with the U.S. intensified.

Better-rated euro zone government debt usually benefits from a flight to safety in troubled times, and on Monday their yields - which move inversely to price - remained close to their lowest levels in weeks, and in some cases, months.

"The question is what happens when tariffs spill over into real data. I heard my economist saying that some of the Fed regional reports already point to some worries there," said ING strategist Benjamin Schroeder.

"So this makes the Powell speech important this week, if he makes any comments on how the trade tariffs may affect the U.S. economy," he said, referring to U.S. Federal Reserve chair Jerome Powell's scheduled testimony to lawmakers on Tuesday.

Benchmark euro zone bond yields were mostly flat or marginally higher on Monday, with Germany's 10-year government bond yield unchanged at 0.285 percent.

Some investors are now treating a recently issued German August 2028 bond as the new 10-year benchmark; that bond was yielding 0.34 percent on Monday.

French and Belgian 10-year benchmark yields rose 1-2 basis points, but were still close to their lowest levels since at least early January hit on Friday.

ITALY RELIEF

Elsewhere, Italian EU Affairs Minister Paulo Savona is reported to have said that Rome has proposed to the EU to be allowed to spend an extra 50 billion euros, which is approximately 2.7 percent of the country's GDP.

"The news that Italy asks for more spending is not a surprise, but the tone from Savona was a lot more conciliatory, so that is reassuring," said Mizuho strategist Antoine Bouvet.

"The end game is to get more spending, not get out of the EU, so if one of the most eurosceptic members takes a pragmatic approach that's more positive," he said.

Italian yields came off morning highs and 10-year yields turned flat on the day while two-year yields were lower 5 basis points at one point to hit a near two-week low of 0.65 percent, before settling at 0.67 percent.

Analysts at ratings agency DBRS said in a statement that came out ahead of the Savona headlines that the expected deviations from current fiscal targets are unlikely to undermine Italy's public debt sustainability materially.