European bonds may gain, pushing the German two-year note to five-day lows, on expectations the European Central Bank will cut interest rates in coming weeks to boost growth, even as inflation exceeds its limit.
"I expect the economic weakness to deepen in Europe," said John Weavers, a senior analyst at MCM Yieldwatch. The bank has cut before when inflation was fast, "so why not cut again?" Weaver sees rates falling in late July or early August, and as reports point to slower growth and equities decline, the long end ``is not a bad place to put money now.''
Yields on German two-year notes were little changed at 4.3 percent, a four-day low, after falling as much as 4 basis points on Friday and 8 basis points in the week.
The yield on the benchmark 10-year German bund was little changed at 5.02 percent, an eight-day low and fell 3 basis points in the week. September bund futures rose 0.01 to 107.00.
The Dow Jones Europe Stoxx 50 Index fell yesterday for the seventh day in eight.
It fell 4.5 percent this week and is on track to close at its lowest since the week ended March 16.
Reports during the week illustrate the bind the ECB is in, as it resists lowering borrowing costs to aid growth while inflation accelerates. The rate, at 2.9 percent in April, has surpassed the ECB's 2 percent annual ceiling for 11 months.
French industrial production fell for the second straight month in April, declining 0.3 percent, while wholesale prices in Germany rose a faster 0.5 percent in May, the fourth straight month of gains, reports Friday showed.
The central bank next sets interest rates on Thursday. All but one of the 12 economists surveyed by Bloomberg News forecast that policy-makers would keep its key rate unchanged.
The ECB trimmed the rate for the first time in 25 months by a quarter point to 4.5 percent on May 10.
The rate on the interest-rate futures contract maturing in September, meanwhile, fell 3 basis points to 4.19 percent. That's 28 basis points below current three-month lending rates, indicating more traders expect the central bank to lower interest rates by then.
Euro-zone consumer price figures will be published tomorrow at 11am London time. The report ``will confirm what we already know, but it won't be well received,'' said Weavers. He sees it accelerating to as much as 3.4 percent.
Still, ``the inflation-scare story should begin to run its course,'' giving the ECB an opportunity to cut as soon as August, said Guy Skinner, who helps oversee PD32 billion (US$45 billion) at Morley Fund Management. Yields on two-year bonds could decline 25 basis points in coming weeks, he said.
Investors will look to the Ifo index of western German business confidence for clues as to the euro economy's strength.
The index probably fell to 92 in May from 92.5 in April, according to the median forecast of 10 economists surveyed by Bloomberg News. That would be the 11th decline in 12 months.
Italian first-quarter gross domestic product and industrial orders for April are due Wednesday. Consumer confidence, and prices from 11 Italian cities, are released Thursday.
Euro-region April industrial production figures will be released Tuesday. In March, production declined 0.2 percent from the previous month, and advanced 3 percent from a year earlier.
Bonds gained earlier on Friday as reports showed consumer prices in the US, the world's biggest economy, rose a faster 0.4 percent in May from 0.3 percent in April. Still, core inflation, which excludes volatile energy and food prices, slowed to 0.1 percent from 0.2 percent in April.
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