By Alun John
LONDON (Reuters) -Euro zone government bond yields dipped on Wednesday as traders digested data showing euro zone business activity contracted again in January while looking ahead to Thursday's European Central Bank meeting.
Germany's 10 year yield, the benchmark for the euro zone was at 2.31%, down around one basis point (bp), retracing some of the previous day's 9 basis point increase which took it to a 7-week high.
The yield has climbed fairly steadily this year, having dipped below 2% in late 2023 on market bets that central bank rate cuts would come as soon as March this year, expectations that have since been pushed back.
On the agenda on Wednesday was the release of activity data which showed the euro zone's preliminary composite PMI rose to 47.9 this month from December's 47.6, just shy of expectations in a Reuters poll for 48.0 but marking its eighth month below the 50 level separating growth from contraction.
The manufacturing outlook did improve somewhat but remained in contractionary territory and was partly offset by a steeper decline in the bloc's dominant services industry.
"Soft services PMI again, Europe is stuck in a rut," said Kenneth Broux senior strategist FX and rates at Societe Generale (EPA:SOGN).
"The ECB should understand that wages do not pose a problem to inflation when demand is weak and bank credit conditions are tight," he added.
The ECB has singled out wages as the biggest inflationary risk with unemployment at a record low. ECB chief economist Philip Lane said this month that crucial wage data would only become fully available by the ECB's June 6 meeting, potentially delaying the first rate cut until then.
Market pricing currently reflects expectations that the first rate cut is more likely than not in April, though ECB policy makers pushed back on such expectations before they entered their quiet period ahead of Thursday's meeting.
Investors are waiting for European policymakers to start adjusting their language and open the door to rate cuts, as the Federal Reserve did at its December meeting.
But Broux said Thursday's meeting would be too soon for that. "Nothing before March when they have the latest forecasts," he said.
Italy's 10 year yield dipped 3 basis points to 3.90%,, while the spread between Germany and Italy's 10 year yields was at 155 bps. It hit earlier in the session 150.5 bps, its narrowest level since June.
Rate cuts are seen as broadly supportive for the euro zone periphery.
Germany's two year yield was down 0.5 bps at 2.71% and Italy's two year yield was down 1.5 bps at 3.23%.