German bond yields edge higher, focus on next ECB steps

MILAN: German government bond yields edged higher on Thursday, with investors weighing risk-aversion triggered by the war in Ukraine against potential monetary policy tightening due to inflation pressures.

German inflation is likely to be higher this year than a recently raised forecast, and the European Central Bank should keep its focus on normalising monetary policy, Bundesbank President Joachim Nagel said on Wednesday.

But ECB chief economist Philip Lane said the central bank should tolerate the current spike in inflation, driven by a "shock" in the supply of energy and other goods.

"This might mean the ECB committing to very little, including asset purchases, to maintain full optionality for H2," Citi analysts said.

But some analysts believe that the ECB will have to step in soon to tame inflation, even if it will not commit to any monetary policy change next week.

"The Bundesbank's warning about 5% average inflation in Germany this year fits the picture. While the surge in energy prices is certainly the main driver of headline inflation, a closer look at the core components confirms that the pressure keeps broadening," Commerzbank analysts said.

They expect the euro zone headline harmonised index of consumer prices (HICP) to rise to 6.4% year-on-year in March.

Germany's 10-year government bond yield, the benchmark of the bloc, rose one basis point to 0.022%.

It was at 0.029% on Feb. 3, right before the ECB's hawkish shift.

"The statement by EU's Dombrovskis about not applying 'strict EU debt rules in 2023' is not surprising but underlines that fiscal policy cannot be counted on to become more restrictive," they added.

European Commission Vice President Valdis Dombrovskis said on Wednesday that the bloc would not be applying its one-twentieth rule for countries with a debt ratio above 60% of GDP next year.

Generally, the rule is that a country that has public debt higher than 60% of its GDP must reduce it by one-twentieth of the excess every year -- a rate which high-debt countries cannot afford to apply.

Italian bonds underperformed their peers after outperforming recently, with the 10-year yield rising 3.5 bps to 1.57%.

The spread between Italian and German 10-year yields widened to 153 bps, not far from its levels seen right before ECB's hawkish shift on Feb. 3.