Euro zone sovereign bond yields fell and money markets increased their bets on future policy rate cuts on Wednesday after data from Germany's most populous state of North Rhine-Westphalia (NRW) supported expectations for a drop in German inflation.

Consumer prices in the German state of NRW fell by 0.3% month-on-month in November and were up by 3.0% year-on-year, the state's statistics office said on Wednesday.

Data from German states is used to calculate a preliminary inflation figure, which will be released later in the day.

Analysts said the NRW figure was much lower than the consensus for the non-harmonised aggregate German headline CPI, expected to fall from 3.8% year-on-year to 3.5%.

"Our economists are looking for a larger decline in this morning's German CPIs than the consensus, which is corroborated by the weaker NRW figures which are already out," said Michael Leister, head of interest rates research at Commerzbank.

Spain's 12-month inflation rate fell to 3.2% in November.

Germany's 10-year government bond yield, the benchmark for the euro area, fell six basis points (bps) to 2.43% after briefly hitting 2.418%, its lowest since early August.

European Central Bank euro short-term rate (ESTR) forwards priced in a policy rate reduction of over 105 basis points (bps) in 2024 from around 95 bps the day before.

They also discount a 90% chance of a first 25 bps rate cut in April 2024.

Borrowing costs on both sides of the Atlantic have dropped recently as central bank officials have failed to push back against expectations for quick rate cuts in 2024.

Sovereign bond yields fell the day before after comments from Federal Reserve governor Christopher Waller signalled a cut in interest rates may be on the horizon.

However, Bundesbank chief Joachim Nagel said the ECB may need to raise interest rates again if the inflation outlook worsens.

Italy's 10-year government bond yield, the benchmark for the euro area's periphery, dropped five bps to 4.21%, a fresh three-month low.

The spread between Italian and German 10-year yields - a gauge of the premium investors demand to hold debt of the euro area's most indebted countries - was at 175 bps. It hit 169.5 bps last week, its lowest since Sept 21.

There was a relatively muted reaction to remarks by ECB president Christine Lagarde, who hinted earlier this week at a possible earlier run-off of reinvestments from the Pandemic Emergency Purchase Programme (PEPP).

The central bank can use PEPP reinvestments to support bonds of the euro area's most indebted countries and to avoid fragmentation  - an excessive yield spread widening which could hamper the transmission of monetary policy across the euro area.

  - Reuters