Bund yields hit fresh 12-year high, Italian spread widens

The euro area's benchmark Bund yield hit a fresh 12-year high on Thursday as easing inflation data failed to trigger expectations that the European Central Bank might soften its policy stance.

The euro area's benchmark Bund yield hit a fresh 12-year high on Thursday as easing inflation data failed to trigger expectations that the European Central Bank might soften its policy stance. Meanwhile, the risk-premium over Italian debt hit a 6-month high, after the government cut its growth forecasts for this year and next and hiked its budget deficit targets.

German inflation fell in September to its lowest level since Russia invaded Ukraine, data showed on Thursday. "Inflation is easing in Germany, but this is not enough to soften the ECB stance," said Francesco Maria Di Bella, fixed income strategist at Unicredit.

"We already expected a significant deceleration, primarily due to base effects," he added. "Oil prices keep rising, fuelling fears that the central banks' fight against inflation was not over yet." Spain's headline inflation rose 3.5% in September, boosted by soaring energy cost.

Germany's 10-year bond yield was last up 9.8 bps at 2.93% after hitting its highest level since July 2011, at 2.942%. It recorded its biggest daily rise since early July. "If momentum continues, the 10Y Bund yield could test the 3% threshold," Unicredit Di Bella argued.

Germany's 2-year yield, most sensitive to expectations for policy rates, was up 5.5 bps at 3.286%. It hit highest level since 2008 at 3.393% in early July.

"Reversed base effects are now the main driver of the sharp drop in German headline inflation," said Carsten Brezeski, global head of macro at ING. "Data in Germany and many other European countries continues to be surrounded by more statistical noise than usual, making it harder for the ECB to take them at face value," he added.

Market bets on ECB rate hikes price in an around 25% chance of a further 25 bps increase by year-end, roughly in line with previous days. Five economic institutes are predicting gross domestic product in Germany will contract by 0.6% in 2023, as rising interest rates take their toll on the euro zone's largest economy and high inflation depresses consumption.

"Base effects from government interventions in 2022 will likely produce a brief inflation surge in December this year and prospective tax increases will likely add to price pressures in January 2024," said Salomon Fiedler, economist at Berenberg. "However, we expect the downtrend in the annual rate to resume after the December spike," he added.

Euro zone economic sentiment fell for a fifth consecutive month in September, although by slightly less than expected, as the mood in services, retail and among consumers slipped, but for the industry, it improved after seven months of decline. Italy's 10-year government bond, the benchmark for the euro area's periphery, jumped 16 bps to 4.94% after hitting its highest level in almost 11 years at 4.96%. It recorded its biggest daily rise since early July.

The spread between Italian and German 10-year yields was last at 196 bps after hitting its widest level in over six months at 199.80 bps.