Germany's 10-year yield rises above 1% as markets weigh rate hike outlook

Benchmark German 10-year government bond yields rose above 1% for the first time in two weeks on Friday, as markets assessed what the U.S. central bank's next rate hike would look like and Britain's economy slowed less than expected. Wednesday's data showing that U.S. consumer prices were unchanged in July, because of a sharp drop in the cost of gasoline, came as a relief to markets.

Benchmark German 10-year government bond yields rose above 1% for the first time in two weeks on Friday, as markets assessed what the U.S. central bank's next rate hike would look like and Britain's economy slowed less than expected.

Wednesday's data showing that U.S. consumer prices were unchanged in July, because of a sharp drop in the cost of gasoline, came as a relief to markets. The news followed month after month of higher than expected inflation and sent bond yields plunging as traders sharply cut their bets on a 75 basis-point (bp) hike by the U.S. Federal Reserve in September.

But several Fed officials have pushed back against the market reaction, emphasising that the bank will keep tightening monetary policy until price pressures are broken. That pushed bond yields back higher from their inflation data-driven fall. On Friday, Germany's 10-year yield, the benchmark for the euro area, rose above 1% for the first time since July 28. Earlier this month, it fell as low as 0.68%, as weak economic data fuelling recession fears drove up bond prices sharply.

By 1435 GMT, the yield was up 2 basis points at 0.989%. "There was an element of catch up needed because Treasuries sold off a bit more post (the) European market close yesterday," said Lyn Graham-Taylor, a senior rates strategist at Rabobank.

In contrast to German bonds, 10-year Treasury yields were down 3 bps on the day. Data showing Britain's economy contracted much less than expected also put upward pressure on bond yields, with gilts leading Friday's bond sell-off. Ten-year yields in Britain were last up 5 bps on the day.

HIGH VOLATILITY "We got used to really high levels of volatility in July, but I think you've also got now quiet summer markets," Graham-Taylor said.

"More thin liquidity might be adding to relatively small (developments), something starts, people jump on the bandwagon, but it's not based on any new market developments." In the euro area, where July inflation surprised on the upside, markets have held on to their rate hike bets. Money markets still price in a full probability of a 50 bp hike in September, Refinitiv data shows.

"If you look at (euro zone) inflation forecasts in contrast to the United States they still suggest the peak could be higher and could be later than initially pencilled in," said Patrick Saner, head of macro strategy at Swiss Re. "Given that they (the ECB) focus on realised inflation outcomes for now and if you believe that there is still a peak ahead of us, which we do, another 50 (bps hike) is definitely reasonable."

A key market gauge of long-term inflation expectations rose to 2.1125% on Friday, its highest since July 4. Italian bonds underperformed, with 10-year yields up 6 bps to 3.07%, pushing the closely-watched risk premium over German bonds to 210 bps from 203 bps on Thursday.

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