Aplox Agency

Euro zone industrial production fell in May by more than expected, driven down mostly by a drop in the output of non-durable consumer goods such as food and clothes, data released on Wednesday showed.

The European Union's statistics office Eurostat said industrial output in the 19 countries sharing the euro fell 1.0% month-on-month, whereas economists polled by Reuters had expected a 0.2% decline.

Year-on-year, production massively increased as the economy recovers from the worst phase of the COVID-19 pandemic in 2020. However, the surge of 20.5% was lower than the average forecast by economists in a Reuters poll of 22.2%.

The pace of the recovery also slowed down after the 39.4% increase of output in April from a year earlier.

The biggest fall in May from April was of non-durable consumer goods, for which output dropped by 2.3%, its first decline this year and its steepest decrease since April 2020.

Production also dropped 1.6% for capital goods, such as machinery, which may indicate lower output in the future.

Energy production was down by 1.9% on the month, while output of durable consumer goods, such as cars or fridges, rose by 1.6%.

The month-on-month fall in May was compounded by a downward revision of production data for April, when output increased 0.6%, instead of the 0.8% that Eurostat had estimated last month.

Euro zone production had also risen month-on-month in March, by 0.5%, but declined by 1.3% in February, Eurostat data showed.

Euro zone government bond yields edged down on Wednesday, with German borrowing costs pulling back from one-week highs as comments from Federal Reserve chief Jerome Powell suggested the central bank was in no hurry to dial back emergency stimulus.

The U.S. job market "is still a ways off" from the progress the Fed wants to see before reducing its support for the economy, while current high inflation will ease "in coming months," Powell said in remarks prepared for a congressional hearing.

Euro zone bond yields, which had been steady ahead of Powell's comments, edged lower.

Germany's benchmark 10-year bond yield was last down half a basis point at -0.30%, having briefly touched a one-week high at -0.27% in early trade.

A rise in long-dated U.S. Treasury yields on Tuesday following weak demand for a $24 billion sale of 30-year bonds and a 3.39 billion euro ($4.00 billion) sale of 10-year German bonds had put some upward pressure on euro zone bond yields.

But price action was generally muted ahead of Powell's testimony to Congress.

Most other euro zone bond yields also nudged lower.

German Bund yields fell to three-month lows around -0.34% last week as markets reassessed the outlook for world growth and inflation.

Germany's 10-year bond yield https://fingfx.thomsonreuters.com/gfx/mkt/azgpoqxenpd/DE1407.png

Powell's comments come a day after data showed the U.S. consumer price index increased 0.9% last month, the largest gain since June 2008, after advancing 0.6% in May.

So far, the Fed and the European Central Bank have said they will look past any near-term rise in inflation, which is likely to be driven by one-off factors.

But another strong U.S. inflation print is leading to questions over whether a pick-up in inflation really is transitory.

Analysts said an expectation the ECB would confirm its dovish stance at next week's policy meeting - the first after a strategy review - continued to support euro zone bond markets.

Florian Späte, senior bond strategist at Generali (MI:GASI) Investments, said he expected bond yields to rise further out.

"We don't think the recent drop in yields will last," he said. "Going forward, we think there is leeway for higher yields in the U.S. and Europe."

Elsewhere, Portugal sold 914 million euros of bonds.

($1 = 0.8480 euros)

U.S. Federal Reserve Chair Jerome Powell begins two days of grilling by U.S. lawmakers on Wednesday with the country facing faster-than-anticipated inflation and a new rise in coronavirus infections, a combination that could pull the Fed's outlook in opposing directions.

In sessions that begin at noon before the House Financial Services committee, Powell in opening remarks and in answer to questions by lawmakers will have to resolve a tension that has emerged just in the four weeks since the Federal Open Market Committee met in June: Whether the spread of the coronavirus Delta variant or inflation poses the greater risk both to the economic recovery and to the Fed's response to it.

The Fed's June meeting saw officials begin a move towards post-pandemic policy, with some of them poised to tighten financial conditions sooner to ensure inflation remains contained. Renewed coronavirus risks, if they materialize, could push the Fed in the other direction of keeping support for the recovery in place longer in case household and business spending wanes amid new infections.

Falling Treasury bond yields have indicated concern among investors about slowing U.S. growth, even as new data on prices this week showed consumers paying appreciably more for goods and services from appliances to fabric, beef and rent.

Yields, long-run inflation outlook dip https://graphics.reuters.com/USA-FED/HEARING/jznvnyabkpl/chart_eikon.jpg

Powell's view of inflation is likely to be a central focus among House members on Wednesday and Senate Banking Committee members on Thursday, all of them likely hearing from constituents about those rising bills.

In a report to Congress last week the Fed said that as the "extraordinary circumstances" of the reopening subside, "supply and demand should become better aligned, and inflation is widely expected to move down."

Each month that inflation remains elevated, however, makes it harder for Powell and the Fed to stick to that conviction. Some analysts feel the moment has already passed.

Though the Fed wants inflation to run above its 2% target for a while to offset years of weak pricing, "there is a threshold for their tolerance," said Ambrose Crofton, a global market strategist with J.P. Morgan Asset Management in London. "The consistent upside inflation surprises of recent months suggest that it is no longer appropriate for the Fed to have its foot firmly on the accelerator."

The "accelerator" includes $120 billion in monthly bond purchases as well as a target short-term interest rate pinned near zero. Rates are likely to remain unchanged perhaps into 2023 or longer. Discussion already has begun on when to reduce the bond purchases.