Euro zone bond yields head back up, Italy/German bond spread wider
Euro zone government bond yields edged back up on Wednesday after two days of falls as attention returned to high inflation and tighter monetary policy. The gap between closely-watched Italian and German 10-year bond yields widened to just over 178 basis points, its highest since July 2020, in a sign of investor unease over European Central Bank tightening.
News that Russia halted gas supplies to Bulgaria and Poland for rejecting its demand to pay in roubles, only added to short-term risks to inflation while weighing on long-term growth prospects, analysts said. Growing concerns about the global economic outlook, especially as China battles a renewed COVID-19 outbreak, has pushed bond yields off multi-year highs.
But with inflation running hot, the ECB was still expected to raise rates sooner rather than later. "Frankly, inflation pressure is too high for central banks to look at anything other than inflation -- even if that is at the detriment of a recession in 2024, which we see as the most probably outcome," said Peter Chatwell, head of head of multi-asset strategy at Mizuho.
"That means 10-year yields should be capped, while the short-end has to deal with the likely aggressive monetary tightening we are likely to get from the ECB." Germany's 10-year Bund yield was up two basis points on the day at 0.82%, holding below roughly seven-year highs touched on Monday at around 0.97%.
Italy's 10-year yield was up 5 bps on the day at 2.59% , keeping the yield gap over safer German bonds at more than 175 bps. Markets price in about 80 bps worth of ECB rate hikes in total by year-end, while a key gauge of long-term inflation expectations rose on Wednesday to around 2.40%, heading back to recent decade highs.
Surprisingly strong inflation data from Australia, showing consumer prices surged at the fastest annual pace in two decades, highlighted that major central banks have little option but to respond to surging price pressures. In the euro area, a weakening in the euro to five-year lows against the dollar adds to upward pressure on inflation - another headache for ECB policymakers that have become more vocal about the need to contain inflation.
ECB President Christine Lagarde is expected to speak later in the day. "We've argued that with the barrage of hawkish comments of late, only doves have the power to move the market's rate expectations," said ING senior rates strategist Antoine Bouvet.
"President Lagarde in particular has adopted a more moderate tone than other Governing Council members. Any departure from the 'gradualism' rhetoric could be impactful." Elsewhere, Greece and Germany sold new bonds.
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