Euro zone yields hold at higher levels as Fed's Powell speaks

Germany's 10-year government bond yield, the euro area's benchmark, was last up 2 basis points (bps) at 2.43%, around where it stood before Powell's testimony began. Short-dated yields hit new highs and market bets on euro zone interest rates rose to 4% earlier in the session as data from Britain was a stark reminder that the fight against inflation is not over and central banks may tighten further.

Euro zone government bond yields rose on Wednesday as investors focused on central banks' battle against inflation. Yields ticked higher after U.S. Federal Reserve Chair Jerome Powell said before an appearance in front of Congress that the fight against inflation "has a long way to go". They then pared some of their increase as Powell testified before lawmakers.

Traders broadly expect the Fed to raise rates by 25 bps at its meeting in July, taking the target range to 5.25% to 5.5%. Germany's 10-year government bond yield, the euro area's benchmark, was last up 2 basis points (bps) at 2.43%, around where it stood before Powell's testimony began.

Short-dated yields hit new highs and market bets on euro zone interest rates rose to 4% earlier in the session as data from Britain was a stark reminder that the fight against inflation is not over and central banks may tighten further. Euro area short-dated yields have climbed towards levels seen before fears of a banking crisis disrupted financial markets in March.

Germany's 2-year bond yield, the most sensitive to policy rates expectations, rose to its highest since March 10 at 3.235%. It was last up 2 bps at 3.182%. On March 9, the yield hit its highest level since October 2008 at 3.385%.

British consumer price inflation was higher than expected in May, leading investors to ramp up their bets on the Bank of England's next moves on rates. "Being specific to the UK economy – and reflecting the tightness of the labour market – are the strong wage growth numbers," said Gero Jung, chief economist at Mirabaud AM.

"Between February and April, average earnings grew at a near record pace of 7.2% (annualized) – signalling that there are likely strong effects from a wage-price spiral," he added. December 2023 forwards on European Central Bank (ECB) euro short-term rate (ESTR) were at 3.88%, implying market expectations for an ECB depo rate at just under 4% by year-end.

More ECB officials spoke on Wednesday, after governing council Isabel Schnabel's tough talk at the start of the week. Joachim Nagel, the head of Germany's central bank, said that "it would be an error to give up too early" on rate hikes.

Peter Kazimir, Slovakia's central bank chief, said he was keeping an open mind about rates beyond September but he would need a moderation in underlying price growth to stop hiking. France's Francois Villeroy de Galhau took a more nuanced view, emphasizing the duration of high rates over further hikes, which would likely be "limited".

Italy's 10-year bond yield, the benchmark of the periphery, was last up 3 bps to 4.057%. The spread between Italian and German 10-year yields was at 160 bps, after last week hitting its tightest level since April 1 below 150 bps.