Euro zone yields rise as data show cenbanks' inflation fight is not over

Euro zone bond yields rose on Thursday as economic data from both sides of the Atlantic cemented expectations that more interest rate hikes are on the cards as central banks' fight against inflation is not over.

Euro zone bond yields rose on Thursday as economic data from both sides of the Atlantic cemented expectations that more interest rate hikes are on the cards as central banks' fight against inflation is not over. However, long-dated euro area borrowing costs have been trading within the same range in the last few weeks, with traders unwilling to test their recent highs. At the same time, money market bets on where the European Central Bank depo rate will peak remained around 4%.

As ING analysts said in a note to clients, central banks' ability to push terminal rates higher and also influence longer rates appears to run into resistance as it faces market scepticism about how much economies will be able to stomach. Germany's 10-year bond yield, the benchmark for the euro zone, was up 11 basis points (bps) at 2.42%.

Some investors were still cautious as they reckon that the ECB might be forced to cut rates to avoid financial instability risks or a deep recession. The German yield curve briefly deepened its inversion, with the gap between 2-year and 10-year yields hitting a fresh 31-year low around 90 bps earlier in the session. It was last at 85 bps.

An inverted yield curve is usually a reliable indicator of a future recession. The German 2-year yield was up 10 bps at 3.27%. It hit its highest level since October 2008 at 3.385% on March 9.

U.S. Treasury yields rose after data solidified the picture of an economy and job market defying predictions of recession a day after the U.S. central bank chief drove home that there is little room yet to let up on monetary tightening. German inflation rose more than expected in June, interrupting a steady decline since the start of the year in what analysts said was just a blip.

There was better news from Spain for policymakers in their fight against price rises, as data there showed consumer prices rose 1.9% year-on-year in June, their slowest increase since March 2021. The German and Spanish data earlier on Thursday caused Goldman Sachs analysts to revise up slightly their euro area headline inflation forecast.

Countries from the euro area released June inflation figures this week ahead of the aggregate numbers due tomorrow. "We forecast euro zone inflation to decelerate to 5.4% yoy in June from 6.1% in May. The data from member states so far are roughly in line with this call," Salomon Fiedler, economist at Berenberg said.

Italy's 10-year bond yield, the benchmark for the euro zone periphery, rose nearly 14 bps to 4.12%. The spread between Italian and German 10-year yields widened to 167 bps.

Italy is the only euro zone country that has not yet given a green light to a treaty that revises the European Stability Mechanism (ESM)- a fund created in 2012 after the euro zone sovereign debt crisis to provide a financial firewall for members of the currency bloc. Prime Minister Giorgia Meloni said on Wednesday that a parliament vote on the ESM was not about to happen and linked the debate to ongoing discussions on a broader reform of European budget rules.

Leaders of the world's top central banks, including ECB President Christine Lagarde, reaffirmed on Wednesday they think further policy tightening will be needed. An aggressive series of rate hikes from central bankers in Europe and around the world weighed heavily on government bond prices last year and in early 2023.