Euro Zone Bund Yields Spike Amid German Inflation Surge

Euro zone benchmark Bund yields hit a six-month peak due to slightly higher-than-expected German inflation and potential U.S. Federal Reserve rate hikes. Despite easing energy and food prices, core inflation remains high. German 10-year bond yields spiked, influenced by market expectations driven by key officials' statements.

Euro zone benchmark Bund yields surged to their highest level in over six months on Wednesday after data showed German inflation rising slightly more than expected and a Federal Reserve official said the U.S. central bank could hike rates. In Germany, cooling energy and food prices have had an easing effect on inflation this year - but core figures, which excludes those more volatile elements, have remained high.

Germany, Europe's largest economy, publishes its figures before euro zone inflation and the U.S. personal consumption expenditure data which are due to be released on Friday. The German 10-year bond yield, the benchmark for the euro zone bloc, rose 9.5 basis points (bps) to 2.68%, its highest level since Nov. 13.

"The bond market started on the back foot this morning after a Fed official didn’t rule out a rate hike," said Massimiliano Maxia, senior rate strategist at Allianz Global Investors. Bond prices move inversely with yields.

Minneapolis Federal Reserve Bank President Neel Kashkari

said that the U.S. central bank should wait for many more months of positive inflation data before cutting rates, adding it could even tighten its policy if inflation fails to come down. "German data showing that core inflation remained high are more consistent with two than three (European Central Bank) rate cuts in 2024," Maxia said, adding that Allianz Global Investors' forecasts on the ECB easing cycle are roughly in line with the market pricing.

The German 2-year yield, more sensitive to expectations for policy rates, was up 4.5 bps to 3.01%. Money market traders are almost certain that the ECB will cut rates next week and are pricing in less than 60 bps of monetary easing by year-end, which implies two 25-bps moves and a 30% chance of a third cut.

"The modest increase in German EU-harmonised inflation in May reflects mainly a base effect from a cut in prices for transport services last May," said Felix Schmidt, senior economist at Berenberg. "The resulting uptick in German year-on-year inflation does not change our call that inflation will fall to around 2% in the third quarter," he added.

Italy's 10-year government bond yield reached a more than one-month high at 4.006% and was last up 10.5 bps at 4%, while the gap between Italian and German bunds was at 131 bps. The yield spread between U.S. 10-year Treasuries and German bunds narrowed by 2 points to 192 bps, having briefly surged to 196.5 bps, its highest since mid-May, earlier in the day.