Euro zone yields edge down from highest levels in over a decade

20 Feb, 2023

Euro zone government bond yields edged down on Monday but remained close to their highest levels in over a decade, as investors recently scaled back expectations of a short monetary tightening cycle.

Analysts said a firmer growth and inflation outlook in the US had been driving global fixed-income markets even if the European Central Bank’s hawkish remarks further boosted last week’s bond selloff.

The upward euro area rate repricing may hold in the near term, given continued concerns on wage dynamics in the region and its implications for persistence in underlying inflation.

Trading will likely be subdued on Monday, with US markets closed for Presidents’ Day.

Germany’s 10-year government bond yield, the bloc’s benchmark, dropped 1.5 basis points (bps) to 2.447%. It hit its highest since August 2011 at 2.569% at the beginning of January.

Markets await euro area Global flash PMIs on Tuesday, Federal Reserve minutes on Wednesday and the US Personal Consumption Expenditures index, which is the Fed’s preferred measure of inflation, on Friday. German 2-year yields, more sensitive to changes in policy rates, were down 0.5 bps to 2.728% after hitting a new 14-year high at 2.943% last Friday.

It first rose to levels last seen in late 2008 at the end of September 2022. Last Friday, ECB’s Isabel Schnabel said markets could underestimate inflation, supporting an upward repricing of the terminal rate.

Euro zone yields rise as hopes for a quick end of tightening fade

At the same time, Bank of France governor Francois Villeroy de Galhau flagged excess volatility in expectations about the level where rates will peak capping a further rise in bond yields.

“As Villeroy’s statements have been good indications about the bipartisan consensus in the Council, this should take some steam out of ECB terminal rate expectations of 3.75% for the time being,” said Rainer Guntermann, rates strategist at Commerzbank. According to ECB short-term euro rate (ESTR) forwards, the ESTR will peak in September at 3.6%, implying expectations for a depo rate of around 3.7%.

The ESTR published by the ECB reflects banks’ wholesale euro unsecured overnight borrowing costs.

It is usually around 10 bps below the deposit rate. Consumer price dynamics remain the primary concern as they have subdued recently, reflecting an easing of energy prices, while the turning point in core inflation is not yet visible across all major economies.

A key market gauge of inflation expectations rose above 2.4% late last week. Italy’s 10-year government bond yield, seen as the benchmark for the euro area periphery, dropped 2 bps at 4.275%, with the spread between Italian and German 10-year yields at 182 bps.

The Italian 2-year yield was down 2.5 bps at 3.401% after hitting its highest since August 2012 at 3.558% last Friday.

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