Euro zone government bond yields rose on Tuesday as investors reckoned the economic outlook did not support a potential slowdown in the European Central Bank’s (ECB) monetary tightening.
Some analysts are wary of forecasting a recession in the euro area due to resilient growth at the end of last year, falling gas prices and China’s reopening from COVID restrictions. Stocks in China on Tuesday snapped a six-session winning streak, driven by the country’s end to its zero-COVID policy.
Germany’s 10-year government bond yield, the euro area’s benchmark, rose 5.5 basis points (bps) to 2.27%. It hit its highest since 2011 last week at 2.569%.
Despite recent volatility in fixed income markets, forward contracts on ECB euro short-term rate (ESTR) hovered around levels seen right after December’s ECB policy meeting. The August 2023 ESTR forward was around 3.4% after rising to 3.5% on Dec. 15.
Recent data showing peaking headline inflation in the bloc probably won’t be enough to affect the ECB stance as core inflation firmed modestly while policy impulses remain hawkish.
Euro zone bonds steady after recent rally, ample supply in focus
Analysts recalled a recent speech by ECB board member Isabel Schnabel - the most influential voice in the hawkish camp – mentioning a policy objective of taking real yields more decidedly into positive territory.
“Hawkish risks could be in store from Mrs Schnabel’s speech at 11.10 CET (1010 GMT on Tuesday) following the broad-based financial market rally since the start of the year,” said Michael Leister, head of interest rates strategy at Commerzbank.
Several central banks officials are due to speak on Tuesday, including Federal Reserve Chair Jerome Powell. An ECB Economic Bulletin article forecast “very strong” wages growth over the next few quarters, but real wages are still likely to decline, given rapid inflation.
“We expect the view of research staff on that topic is something that resonates with governing council members, and by extension with markets,” ING analysts said. Italy’s 10-year bond yield rose 6.5 bps to 4.23%.
The closely watched spread between Italian and German 10-year yields was at 195 bps; it hit an almost 10-week high at 222 bps a few days after the ECB policy meeting.
“The 200bp mark is emerging as the key hurdle for the 10y BTP-Bund-spread,” according to Commerzbank’s Leister.
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