Italy risk premium rises amid growing ECB rate hike bets

On Friday, money markets continued to ramp up their bets on ECB rate hikes this year, moving back to pricing a full probability of a 25 basis-point rate hike by the bank's July meeting and nearly 95 bps by the end of the year. Traders now also see a roughly 70% chance of a 10 basis-point hike in June following comments overnight from Austrian central bank governor and ECB policymaker Robert Holzmann, who said the ECB will probably raise interest rates at its June meeting.

The risk premium on Italian bonds briefly rose above 200 basis points for the first time since the height of the pandemic on Friday, as traders ramped up bets on rate hikes after hawkish comments from the European Central Bank. The closely-watched gap to German 10-year yields, effectively the risk premium on Italy's debt, rose above two percentage points for the first time since May 2020.

The move came after the 10-year yield surpassed 3% for the first time since late 2018 on Thursday, with a further 5 basis point rise to 3.07% on Friday. It has risen 30 bps this week, the biggest weekly jump in nearly two months. "There's been a pretty steep increase in Italy spread versus Germany," Lyn Graham-Taylor, senior rates strategist at Rabobank, said.

While still below a level that most analysts find concerning, the speed of the move has been in focus as the spread has risen some 50 bps since the start of April and is wider than many analysts and investors expected only a month ago. The moves have come as ECB policymakers are becoming more vocal about normalizing monetary policy quicker than previously expected, with more publicly backing a July rate hike.

The move in the Italian spread is "definitely going to be attracting the interest of the (ECB) governing council. Given the path the ECB is on, all things equal they are going to be tightening monetary policy into a slowdown, it's hard to see that spread not continuing to widen," Graham-Taylor said. On Friday, money markets continued to ramp up their bets on ECB rate hikes this year, moving back to pricing a full probability of a 25 basis-point rate hike by the bank's July meeting and nearly 95 bps by the end of the year.

Traders now also see a roughly 70% chance of a 10 basis-point hike in June following comments overnight from Austrian central bank governor and ECB policymaker Robert Holzmann, who said the ECB will probably raise interest rates at its June meeting. French central bank governor Francois Villeroy de Galhau said the ECB should raise rates to positive territory this year, while German central bank governor Joachim Nagel said the ECB's time window for raising rates in response to record-high inflation is closing. In the broader bond market, Germany's 10-year yield, the benchmark for the bloc, was last up 3 bps to 1.07%, now comfortably above the 1% level breached for the first time since 2015 earlier this week.

Two-year yields, sensitive to rates expectations, were up 3 bps to 0.31% after rising to 0.35% in earlier trade. Later in the session, the focus will be on the U.S. April non-farm payrolls report, which is expected to show slightly fewer jobs were added to the economy in April than in March.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)