Euro zone yields fall as ECB hikes but signals end of tightening

Euro zone government bond yields fell on Thursday after the European Central Bank hiked interest rates by 25 basis points to 4% but signalled it was likely finished with its tightening policy.

Euro zone government bond yields fell on Thursday after the European Central Bank hiked interest rates by 25 basis points to 4% but signalled it was likely finished with its tightening policy. Germany's 10-year bond yield, the bloc's benchmark, was last down 4 basis points (bps) at 2.613%. The yield, which moves inversely to the bond's price, stood at 2.638% just before the decision.

The increase in rates came as the ECB upgraded its inflation forecast for 2024 to 3.2%, confirming Reuters reporting. The central bank's Governing Council said in a statement that "the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target".

Andrew Kenningham, chief Europe economist at Capital Economics, said: "The ECB's decision to raise interest rates by a further 25 bps today probably brings the current tightening cycle to an end. "But given the strength of underlying inflation, we expect rates to remain at this level for at least a year, even though the economy seems to be heading for a recession."

Mike Bell, global liquidity market strategist at JP Morgan Asset Management, added: "With the business surveys indicating an imminent sharp slowdown in growth, the ECB are probably done hiking." The German 2-year bond yield, which is sensitive to interest rate expectations, was last down 2 bps at 3.152%. It traded at 3.158% before the rate increase.

Italy's 10-year bond yield was 7 bps lower at 4.389%. That put the gap between Italy and Germany's 10-year yields at around 176 bps, from 178 bps before the ECB decision. Yields rebounded somewhat when data just after the ECB's move showed that U.S. retail sales came in stronger than expected in August.

Inflation in the euro zone was at 5.3% in August, unchanged from the previous month and well above the ECB's 2% target. Yet it is down sharply from the peak of 10.6% in Oct. 2022. Investor attention now turns to the press conference from ECB President Christine Lagarde, set to start at 1245 GMT.