SYDNEY: Mayhem hit the Australian bond market on Thursday as yields surged to their highest since mid-2019 and futures swung wildly to price in a hike in interest rates as early as May next year.

A torrent of selling carried three-year bond yields to 1.17%, up an eye-watering 39 basis points in just two sessions and the biggest such move since 2009.

Three-year bond futures tumbled 22 ticks to 98.645 while the yield curve bear flattened as investors wagered the Reserve Bank of Australia (RBA) would have to raise rates two years earlier than its current forecast of 2024.

Trading in futures was erratic amid sparse liquidity and widening spreads, but the May contract was implying a cash rate of 0.37% compared to the present 0.1%.

The rout began when the RBA skipped a chance to buy the April 2024 bond that is the linchpin of its yield curve control (YCC) policy, thus threatening to unravel the whole thing.

The RBA has committed to keeping the yield near the 0.1% cash rate, but it shot past 0.2% on Wednesday after inflation surprised on the high side.

Investors were thus stunned when the RBA passed on the chance to buy the bond and quickly took the yield to 0.52%. Last week, the RBA stepped in to buy its April 2024 bond and defend its yield target after an aggressive sell-off.

"The RBA's silence was deafening for the bond market," said Ray Attrill, head of FX strategy at NAB. "The fact it didn't protest the rise in yields clearly raises doubts about its commitment to YCC and triggered a massive selloff."

That in turn fuelled market scepticism the RBA could really keep the cash rate at 0.1% all the way to 2024 as it has projected, and piled pressure on the bank to adjust forward guidance at its November policy meeting next week.

Data on Wednesday showed annual core inflation reached 2.1% in the third quarter.

The central bank had forecast it would not reach 2% until mid-2023.

David Plank, head of Australian economics at ANZ, argued the RBA would now have to lift its inflation forecasts to 2% or more for the entire period out to the end of 2023.

"If so, its current forward guidance would no longer be tenable, and we would expect it to shift to expecting a rate hike in the second half of 2023," said Plank. "A change along these lines would likely see the yield target being dropped altogether."

Plank did note it was still possible the RBA would step in to buy the April 2024 bond on Friday, as it did last week.

"If it does not come in...it will be a clear signal of a change next week," he added.

With all the action in bond markets, the Australian dollar was largely sidelined at $0.7506, stuck between resistance at $0.7536 and support around $0.7479.

The New Zealand dollar was a shade firmer at $0.7176 , but faced major resistance at the recent four-month top of $0.7219.