Euro zone yields rise after ECB as market bets on policy rates above 3.9%

June 16 (Reuters) – German short-dated bond yields hit a fresh 3-month high on Friday and were set to end the week with their most significant rise since mid-April as the Federal Reserve and the European Central Bank suggested that the tightening cycle was not over.

Meanwhile, money markets boosted their bets on the ECB terminal rate to over 3.9%.

The Federal Reserve left rates unchanged on Wednesday but signalled that borrowing costs may still need to rise by as much as half of a percentage point by the end of this year.

The ECB delivered a widely expected 25 bps rate hike on Thursday, with president Christine Lagarde reiterating there was more ground to cover. It also reviewed to the upside its inflation forecasts leading some analysts to raise their projections for the ECB depo rate to peak at 4%.

Germany’s two-year yield, particularly sensitive to changes in policy rate expectations, rose 2 bps to 3.19% on Friday after hitting a fresh 3-month high at 3.206%.

It was set to end the week up 22.5 bps in its biggest rise since mid-April.

“3.75% looks to be a floor for the policy rate, and we expect the ECB to follow July’s hike with another one in September,” said Paul Hollingsworth, chief Europe economist at BNP Paribas, citing the ECB’s unexpected upward revision of its inflation forecasts.

“We continue to expect an extended pause thereafter, with the first cut unlikely to come before mid-2024,” he added.

November 2023 ECB euro short-term rate forwards rose to 3.83%, implying the ECB depo rate would peak above 3.9% by year-end.

Analysts noted that the ECB claimed it remained data-dependent but was also clearly steering markets towards pricing in more tightening until core inflation is on a sustained trajectory, despite weaker economic conditions.

This creates some uncertainty about the level of the terminal rate and increases the risk of overtightening. As a result, money markets are currently pricing in a rate cut of around 25 bps by March-April next year.

Germany’s 10-year government bond yield, the benchmark of the euro area, rose 2 bps to 2.53%.

ECB rate hikes may need to last beyond the summer break, Bundesbank President Joachim Nagel said on Friday, while Finnish central bank Governor Olli Rehn stressed the data-dependent approach of the central bank.

Italian bonds were slightly outperforming their peers with the 10-year yields up 0.5 bps at 4.15%.

The gap between Italian and German 10-year yields was at 159 bps, not far off the 14-month low of 156.8 reached the day before. (Reporting by Stefano Rebaudo; Editing by Conor Humphries)

Similar Posts

Leave a Reply

Your email address will not be published. Required fields are marked *