Euro zone bond rally ends, hit by UK, US sell-off

Euro zone bond yields rose on Thursday, bringing to a halt a sharp rally since last week driven by dovish central bank commentary, as a sell-off in US and UK government bonds also hit the single-currency bloc.

Comments from ECB President Christine Lagarde last week that it was too early for the central bank to discuss slowing its pandemic emergency bond purchases (PEPP), reinforced by remarks from several others, had sent euro area bond yields down sharply in recent sessions.

Euro area yields had risen sharply earlier in the month, with Germany's 10-year yield nearing positive territory last week, driven by speculation that a stronger economic outlook driven by speedier vaccinations in the bloc could prompt the ECB to slow the PEPP purchases at its June 10 meeting.

But that rally came to a halt on Thursday, when Bank of England policymaker Gertjan Vlieghe said the bank could raise rates earlier in 2022 if the economy rebounds faster than expected and headlines on the US White House Proposal expected on Friday emerged.

Those pushed UK and US government bond yields higher, a move that was followed, though to a lesser extent, by higher-rated government bonds in the euro area like Germany's, which often move in tandem with their foreign peers.

ECB policymaker and German central bank governor Jens Weidmann then said governments must curb public spending after the pandemic to avoid a conflict with monetary policy, so that it is clear the bank is not putting monetary policy at the service of fiscal policy.

The extent to which Weidmann would deviate from recent dovish signals by ECB policymakers was being watched particularly closely as he is among the most hawkish at the bank.

"Weidmann didn't have too much impact given his known hawkish credentials so it leaves Bunds subject to bearish (moves) on the other side of the Channel and the Atlantic," said Richard McGuire, head of rates strategy at Rabobank in London, referring to German government bonds.

McGuire added that the fact that Weidmann's comments did not address the near term diminished the likelihood of the ECB slowing its bond buying at its upcoming meeting.

After falling nearly 10 basis points during the last four sessions, Germany's 10-year yield was up 2 bps to -0.19% by 1253 GMT, as were most other 10-year yields.

Italian 10-year bond outperformed, with yields up 1 bp to 0.94%, pushing the closely watched gap with German peers down to 111 bps.

Focus turns to speeches from ECB board member Isabel Schnabel at 1330 and 1500 GMT.