Euro zone yields trade mixed near recent multi-year highs

Euro zone government bond yields held near multi-year highs on Tuesday as the narrative that global central banks would keep interest rates "higher for longer" continued to drive price action.

Euro zone government bond yields held near multi-year highs on Tuesday as the narrative that global central banks would keep interest rates "higher for longer" continued to drive price action. Germany's 10-year government bond yield, the euro area's benchmark, was last down 1 basis point (bp) at 2.779%, having briefly hit a 12-year high of 2.813% in early trade. Bonds yields move inversely with prices.

The policy-sensitive two-year yield was down half a basis point at 3.216%. After raising the deposit rate to a record 4% earlier this month, policymakers from the European Central Bank have provided different interpretations of recent guidance, with some arguing that the next move will be a cut and others saying the chance of another hike could be close to 50%.

ECB President Christine Lagarde on Monday said that interest rates held at current levels will make a substantial contribution towards getting inflation down towards their target of 2% over the medium term. Pricing in derivative markets shows a less than 10% chance of another rate hike from the ECB, but a rate cut is not priced in until July next year.

"The overall message from the last two weeks is that it seems the hiking cycle has come to an end, but that central banks will keep rates higher for longer," said Jens Nærvig Pedersen, director and rates strategist at Danske Bank. "Oil prices have been on the rise and natural gas prices in Europe are creeping higher again so that might fuel concerns about renewed inflationary pressure."

Brent crude futures hit their highest level in 11 months last week, while Dutch and British wholesale gas prices edged back from multi-week highs reached on Monday after an extension to Norwegian maintenance outages. Italy's 10-year yield was last up 3.5 bps at 4.687%, hitting its highest level since October. This pushed the closely watched yield gap between Italian and German 10-year bonds above 190 bps, its widest level since May 11.

Analysts said the ECB putting more focus on reducing excess liquidity could be adding to pressure on peripheral bond markets, while the debate about shrinking the ECB's balance sheet was also likely having an impact. "Tighter liquidity could have implications for the periphery and may be part of the reason why the spread is going wider," Danske Bank's Pedersen said.

Italy is also under growing market scrutiny as Prime Minister Giorgia Meloni is set to announce a new budget against the backdrop of a weakening growth outlook, where recent proposals - such as a watered down levy on bank profits - have triggered confusion among investors. Reuters earlier reported that Italy is likely to raise its 2024 budget deficit target to between 4.1% and 4.3% of gross domestic product (GDP), however, the fiscal gap is seen below 4% of GDP under current trends, allowing leeway for several billion euros to fund measures in the upcoming budget.

Meanwhile, investors were watching a rise in U.S. treasury yields with the benchmark 10-year earlier hitting its highest level since 2007 at 4.566%.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)