Euro zone yields nudge higher as inflation takes centre stage

Short-term interest rates remain higher than long-term ones, a sign that investors are concerned about growth," said Daniele Antonucci, chief economist and macro strategist at Quintet Private Bank. Data on Friday showed inflation in France fell to its lowest in six months, although the drop was slightly less than forecast, while in the Netherlands, weaker energy prices drove inflation to its lowest since October 2021.

Euro zone government bond yields edged up on Friday as receding concerns about the prospects of a global banking crisis offset the likelihood of persistent inflation in the zone. Euro zone inflation dropped by the most on record in March, according to data on Friday. Core price pressures, which exclude food and energy, accelerated, which keeps the heat on the European Central Bank to keep raising rates.

Two-year German Schatz yields, the most sensitive to shifts in expectations for interest rates, were up 4 basis points (bps) at 2.79%. They've risen by 41 bps this week - their largest weekly increase since early 1990. The rise has been driven largely by proof that regulators, central banks and governments on both sides of the Atlantic are committed to preventing the spread of any problems at smaller lenders to the wider financial system.

This has boosted equities and delivered a blow to safe-haven assets like government bonds this week. However, now the worst of the banking crisis appears to have been contained for the time being, investors are taking another look at the inflation outlook and what that might mean for rates.

"The inflation story is still not very comfortable, whether here in Europe or in the U.S. This morning’s inflation data reinforces that message," Daiwa Capital senior economist Chris Scicluna said. "We’re still looking at further tightening from ECB," he added. A market-based gauge of long-term inflation expectations eased to 2.43% from 2.45% prior to the data, but this was still around its highest for two weeks.

Benchmark German Bund yields were up 1 bps at 2.371%, leaving the discount to two-year yields at -41.3 bps, the most in two weeks. "The outlook for the European Central Bank is more uncertain, with risks of a higher terminal rate. Short-term interest rates remain higher than long-term ones, a sign that investors are concerned about growth," said Daniele Antonucci, chief economist and macro strategist at Quintet Private Bank.

Data on Friday showed inflation in France fell to its lowest in six months, although the drop was slightly less than forecast, while in the Netherlands, weaker energy prices drove inflation to its lowest since October 2021. In Spain, data on Thursday showed inflation fell to its lowest since August 2021.

Inflation in Germany, harmonised to compare with other European Union countries, rose by 7.8% in the year in March, above forecasts for a reading of 7.5%. In terms of ECB expectations, interest rate derivatives show traders expect rates to peak around 3.65% by November this year. This marks a stark contrast with the beginning of the month, when money markets showed the expectation was for rates to continue to rise into early next year.

The ECB is a long way off hitting its target rate of 2% for consumer inflation, but policymakers will also want to see the cumulative effect of the 350 bps of rate increases that they've implemented so far, before committing to more big increases. "People will have to see what effect that that tightening has on growth going forward in due course," Daiwa's Scicluna said.

Economists at ABN Amro this week increased their forecast for euro zone inflation to reach 4.9% in 2023, up from a previous estimate of 3.5%. Around the periphery, Italian 10-year yields eased 2 bps to 4.199%, bringing their premium to Bunds to 181.4 bps. That spread was around 172 bps at the start of the month, highlighting how far German debt yields have dropped relative to others these past few weeks.

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