Next on traders' watchlist is the U.S. Federal Reserve's policy decision and news conference by Chair Jerome Powell later in the day, followed by the Bank of England and European Central Bank meetings on Thursday. Friday's focus will be on U.S. payrolls data.
Germany's 10-year government bond yield was at 2.298%, up 2 basis points (bps) on the day, reversing an earlier small fall and holding near Monday's two-week high of 2.325%. Italy's 10-year yield rose 3 bps to 4.3%, not far from Monday's two-week high of 4.339%.
Headline inflation in the euro area fell to 8.5% in January, down from 9.2% in the previous month and below the 9% consensus forecast.
But core inflation - excluding food and fuel prices - picked up to 7% from 6.9%, while an even narrower measure watched closely by the ECB held steady at 5.2%, exceeding forecasts for 5.1%. "It's a bit of a middling print. It's a bit of a shoulder shrug," said Nick Chatters, investment manager, Aegon Asset Management.
"And I think if you look at the market reaction it's one of those days where I think the market really just rallied into the print, so yields fell, and then once we got the data yields, reversed and sold back off again. So I don't think there's a lot in it." The inflation prints are not seen changing expectations for the ECB to raise its deposit rate by 50 bps to 2.5% on Thursday, having already hiked by 250 bps since beginning its tightening cycle in July.
But the outlook after that is less clear. Markets are pricing rate cuts later this year.
The relentless pace of central bank rate increases prompted a significant sell-off in global government bonds in 2022 that pushed yields, which move inversely to prices, to their highest in years.
The Fed's decision is due at 2:00 p.m. ET (1900 GMT) and money markets show traders expect the Fed to raise rates from their current 4.25-4.50% target range by just 25 bps.
Even though Chair Jerome Powell and his colleagues have
repeatedly expressed their concern about the persistence of
inflation, traders expect no more than a further couple of small
increases that will see rates peak around 4.9% by June.
Germany's two-year Schatz yield , which is more
responsive to shifts in expectations for interest rates and
inflation, was up 5 bps at 2.674%, while Italian two-year yields , which hit a four-week high on Tuesday, were up 5 bps
at 3.294%.
(Reporting by Alun John, Susan Mathew, and Harry Robertson;
Editing by Emelia Sithole-Matarise and John Stonestreet)
