Euro zone government bond yields edged higher on Wednesday amid mixed signals about the monetary tightening path from economic data and central banks’ officials.
Germany’s 10-year government bond yield, the bloc’s benchmark, was up 2 basis points (bps) at 2.28%. Its 2-year bond yield, the most sensitive to expectations for policy rates, was up 3 bps at 2.66%.
ECB governing council member Gabriel Makhlouf on Tuesday argued that the euro area would need a stronger monetary policy response if it ends up in a wage-price spiral.
German industrial orders rose more than expected in February, increasing by 4.8% from the previous month.
In the United States, Treasury yields slid on Tuesday after U.S. job openings suggested the labour market was finally cooling and could allow the Federal Reserve to loosen its grip on monetary policy.
After the release of data, the Fed’s Loretta Mester said the U.S. central bank likely has more interest rate rises ahead amid signs the recent banking sector troubles have been contained.
Sticky inflation
Analysts said that even a recession and a drop in inflation might not end inflation fears.
The so-called “Three Ds” - demographics, decarbonisation, and deglobalisation – are fuelling some investors’ view that a subsequent economic recovery will see a return of above-target inflation.
That is one of the reasons why some expect long-dated rates to have little to fall in this cycle, as central banks’ more dovish action would result in a higher inflation premium.
Market expectations about the ECB terminal rate stood at around 3.5%, with the September 2023 ECB euro short-term rate (ESTR) forward at 3.45%, implying an ECB deposit facility rate at 3.55% by summer.
The November 2023 forward peaked at around 4% before fears of a banking crisis hit markets in mid-March.
“Yesterday’s price action was another sign that lower inflationary pressures may not be enough to content the ECB,” said Antoine Gaveau, European rate strategist at Citi, who pointed to recent ECB officials’ comments “keeping the door to a 50bp hike in May open.”
Markets see an 80% chance of a 25 bps rate hike in May.
Citi economists continue to see ECB hiking towards a peak of 4%, although now via 25 bps increases.
Data on Tuesday showed euro zone producer prices fell more than expected, while consumers cut their inflation expectations.
Italy’s 10-year government bond yield rose 2 bps to 4.15%, with the spread between Italian and German 10-year yields - a gauge of confidence in the euro zone’s more indebted countries – at 185 bps.
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