Euro zone yields, ECB hike bets rise after inflation data

On Thursday, Europe's biggest economy Germany reported that inflation came in higher than expected, pushing bond yields sharply higher. Euro zone money markets have already moved to price in 90 basis points of European Central Bank rate hikes by year-end on Friday before the bloc-wide data, compared to 85 bps following German data on Thursday.

Euro zone bond yields rose on Friday as data showed inflation in the 19-nation bloc is becoming increasingly broad-based. The data showed the rate of energy inflation actually declined from March, while price growth in food, services and non-energy industrial goods accelerated further.

French and Italian inflation readings also rose more than expected on Friday. On Thursday, Europe's biggest economy Germany reported that inflation came in higher than expected, pushing bond yields sharply higher.

Euro zone money markets have already moved to price in 90 basis points of European Central Bank rate hikes by year-end on Friday before the bloc-wide data, compared to 85 bps following German data on Thursday. A key market gauge of euro zone inflation expectations rose more than 6 bps on the day to 2.5666%, the highest since 2012, according to ECB data.

After falling in earlier trade, Germany's 10-year yield, the benchmark for the bloc, was up 3 bps to 0.93%, adding to a 9 bps rise on Thursday Two-year yields, sensitive to interest rate expectations, led the sell-off, and were up 6 bps in Germany to 0.25%.

"The market is still really sensitive with regard to the inflation data, also the breakdown between headline and core inflation," said Rainer Guntermann, rates strategist at Commerzbank. Inflation pressures have pushed bond yields sharply higher this year as hawkish signals from central banks have led investors to sharply reprice their rates expectations.

Benchmark 10-year German bond yields are set for their fifth straight month of rises, up 38 bps in April. On Friday, Southern European bonds, the biggest beneficiaries of ECB stimulus, were the worst hit. Greece's 10-year yield rose 25 bps to 3.41%, the highest since March 2020.

Guntermann at Commerzbank saw no local drivers behind the move. "It seems to be this general sentiment that ECB support is about to fade and fade a bit faster than some people thought until now," he said. Reuters reported recently that the bank's policymakers were keen to end their bond purchases as early as possible and raise rates as soon as July.

Greece is more vulnerable as the ECB could only purchase its debt under its pandemic programme, under which new purchses ended in March. A debt sale earlier this week also likely adding pressure. Italy's borrowing costs rose to a three-year high at an auction on Friday, where it raised 8 billion euros from a new 10-year bond, a five-year bond and a floating-rate seven-year bond.

The closely-watched risk premium Italy pays for 10-year debt over Germany has risen 36 basis points this month, the biggest move since April 2020. On Friday, it briefly touched the highest since June 2020 at over 184 bps. The 10-year yield itself climbed 74 bps, the biggest monthly jump since May 2018. It was up 7 bps on Friday to 2.79%. a new high since March 2020.