Euro zone yields edge higher after ECB, investors see less aggressive stance

The ECB pushed through another big interest rate increase on Thursday, and highlighted that an elevated level of uncertainty reinforced the importance of a data-dependent approach to the Governing Council’s policy rate decisions. A sharp fall in Credit Suisse shares on Wednesday reignited concerns about a banking crisis on both sides of the Atlantic after the collapse of Silicon Valley Bank (SVB) in the United States.

Euro zone government bond yields edged higher on Thursday after the European Central Bank (ECB) raised rates by 50 basis points, as investors expect the ECB to slow down its monetary tightening while assessing financial stability risks. The ECB pushed through another big interest rate increase on Thursday, and highlighted that an elevated level of uncertainty reinforced the importance of a data-dependent approach to the Governing Council’s policy rate decisions.

A sharp fall in Credit Suisse shares on Wednesday reignited concerns about a banking crisis on both sides of the Atlantic after the collapse of Silicon Valley Bank (SVB) in the United States. Expectations for the peak in the ECB deposit rate at the end of 2023 dropped to as low as 3.1% on Wednesday from 4.1% last Thursday before fears about the impact of SVB's troubles triggered a rush into safe-haven assets.

The November 2023 ECB ESTR forward rose to 3.075% from 3.025% before the ECB statement, implying a depo rate at around 3.175% by year-end. Germany's 2-year bond yield rose 7.5 bps to 2.457%, after dropping almost 90 bps since last Thursday. It had hit its highest since October 2008 at 3.385% last Thursday.

"The ECB move met analyst expectations, with a 50 bps rate hike while stressing that next decisions will be data-dependent," said Massimiliano Maxia, a senior fixed-income specialist at Allianz Global Investors. "We think it was the right thing to do as a smaller hike might have triggered further concerns about the stability of the financial system," he added.

Pricing in derivatives markets before the ECB statement, showed investors reckoned there was around a 60% chance of a 50-bps hike and a 40% likelihood of a 25-bp increase. Investors were reassured by the Swiss National Bank's action to support Credit Suisse, which send its shares up 21%.

But the bank has not yet made up for losses on Wednesday when its shares dropped 24% after its biggest investor said it would be unable to provide further support to the bank, which has been hit by a series of scandals. Investors were already on edge following the failure of Silicon Valley Bank last week.

“Obviously the future policy path will depend crucially on what happens in the banking system, if the turbulence can be contained or if it gets worse again,” said Jussi Hiljanen, chief European rates strategist, SEB. Germany's 10-year bond yield, the bloc's benchmark, rose 6 bps to 2.18%.

Italy's 10-year yield was up 2 bps to 4.108%, with the closely watched gap between German and Italian borrowing costs tightening to around 192 bps, after it hit a near two-month high of 199 bps on Wednesday. Bond prices remain well above where they were at the start of the month, when Germany's 10-year yield stood at an 11-year high of 2.77%.