Euro zone bond yields rise as central banks hike rates

Euro zone yields, particularly on shorter-dated bonds, have been approaching levels last seen in March, before a banking crisis in the U.S and Switzerland caused them to plunge. Traders expect the ECB to raise rates to a peak of around 4% by December, according to market pricing on Thursday, from the current 3.5% level.

Euro zone government bond yields rose on Thursday as investors digested more monetary tightening from central banks outside the euro area. The Bank of England raised rates by a bigger-than-expected half a percentage point and said there had been "significant" news suggesting British inflation would take longer to fall.

The Swiss National Bank and Norges Bank also tightened their policy, suggesting they could do more. Germany's 10-year bond yield, the euro zone's benchmark, was 6 basis points (bps) higher at 2.49%.

Central banks’ "concern is that beyond the ongoing moderation in year-on-year headline inflation, underlying price pressures remain too high," said Christian Keller head of economic research at Barclays, in a research note. "Thus far, inflation expectations have generally remained surprisingly well anchored," he added, mentioning the European Central Bank's (ECB) Consumer Expectations Survey and the University of Michigan Survey for the U.S. "It is crucial that these expectations are not disappointed".

The German 2-year bond yield, which is highly sensitive to changes in interest rate expectations, was up 8.5 bps at 3.27%, after hitting 3.275%, its highest since March 10. Data on Wednesday showed British inflation failed to fall as expected in May, instead holding at 8.7%. The data sent yields on 2-year British bonds, or Gilts, to their highest since 2008.

Italy's 10-year bond yield was up 7.5 bps at 4.13%. It is seen as the benchmark for the more indebted countries in the euro zone. Yields were largely unmoved by testimony from U.S. Federal Reserve Chair Jerome Powell in front of Congress on Wednesday, in which he said two more 25 bp rate hikes by the end of the year "is a pretty good guess" of what will happen.

The Fed has hiked rates by 500 bps since March 2022 to a range of 5% to 5.25%. Euro zone yields, particularly on shorter-dated bonds, have been approaching levels last seen in March, before a banking crisis in the U.S and Switzerland caused them to plunge.

Traders expect the ECB to raise rates to a peak of around 4% by December, according to market pricing on Thursday, from the current 3.5% level. The closely watched gap between Italian and German 10-year yields widened slightly to 162 bps. Last week it hit its tightest level since April 1, below 150 bps.

Europe is running out of available workers and sweeping changes are needed, otherwise a hot labour market will keep pushing inflation higher, making it harder for the ECB to contain price pressures, Bundesbank President Joachim Nagel said.