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LONDON: Euro zone bond yields slipped back on Friday as markets assessed the reduction of monetary stimulus from the European Central Bank as being roughly in line with expectations. Borrowing costs shot up on Thursday after Britain jolted traders by becoming the first G7 economy to hike interest rates since the onset of the pandemic, just before the ECB reined in stimulus.

Germany’s 10-year government bond yield, the euro zone’s benchmark, was down 2.5 basis points at -0.371%, after rising 1.5 bps on Thursday. “We consider the ECB package bullish for the front end of the euro zone curve, but challenging for spreads, particularly in the periphery,” Commerzbank analysts said to customers.

They said the plan to keep the ECB’s Asset Purchase Programme (APP) for longer while maintaining the sequencing “renders a rate hike next year very unlikely,” but flexibility conditional on stressed conditions sounds less reassuring for the periphery. Italian 10-year government bond yield was down 5.8 basis points at 0.915%, reversing Thursday’s 5 bps rise.

The chart below shows Italy’s 10-year bond yield moves after Thursday’s ECB statement. Adrian Hilton, head of global rates and currency at Columbia Threadneedle Investments, said central banks chose to focus “on cementing their inflation-fighting credibility.”

“Time will tell whether this shift is justified, but the enduringly low levels of long-dated bond yields suggest that the market is so far reluctant to price in sustainably higher rate regimes,” he said. ECB policymaker and French central bank head Francois Villeroy de Galhau said on Friday that inflation was “probably” close to its peak in the euro zone.

Analysts said hawkish undertones from the central bank might prevail in the medium term. The governors of Austria, Belgium and Germany dissented with the ECB decision to continue bond purchases for years to come, sources close to the matter told Reuters.

Several conservative policymakers said on Friday the ECB might be underestimating inflation risks. The ECB “did not provide any clarity on the Asset Purchase Programme issuer and issue limit or on the capital key contribution criteria. We still think that the ECB would use some flexibility if needed,” Barclays analysts said.

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