Euro zone yields rise, markets price in a slight chance of a further hike

Reuters · 09/15/2023 08:13
Euro zone yields rise, markets price in a slight chance of a further hike

By Stefano Rebaudo

- Germany's policy-sensitive 2-year yields were on track for their biggest weekly rise since mid-June after the European Central Bank (ECB) raised rates by 25 basis points on Thursday.

Money markets had slowly raised their bets on a tightening move since early September - when they priced just a 20% chance of a rate hike - driving short-dated yields higher.

Germany's 2-year government bond yield DE10YT=RR, sensitive to changes in policy rates, was up 3 basis points (bps) at 3.19%, after hitting 3.192%, a fresh six-week high. It was set for a 12-bp weekly rise, the biggest since mid-June.

The ECB raised its key interest rate to a record high of 4% on Thursday but signalled the hike would likely be its last, stressing the central bank will be data-dependent.

Money markets slightly increased their bets on the tightening cycle right after the ECB statement on Thursday, pricing in a slight chance of an additional 25 bps rate hike by year-end. They are pricing a 24% chance of a tightening move by December EURESTECBM3X4=ICAP from around 20% the day before.

Most analysts believe the ECB tightening cycle is over, and rates will stay at the current levels for an extended period to tame inflation.

Deutsche Bank analysts said in a research they forecast a 12-month pause in the tightening cycle but with upside risks.

"If the market prices rate cuts too quickly, the ECB would have to take compensatory policy action, presumably starting with some verbal intervention to underscore what's implied by this policy stance," they argued.

A good appetite for risky assets on expectations that central banks' tightening cycle is close to an end supported a mild selloff in safe-haven government bonds on Friday.

Bond prices move inversely with yields.

Germany's 10-year government bond yield DE10YT=RR, the benchmark for the euro area, was up 5 bps at 2.64% and set to record a 4 bps rise during the week.

Italy's 10-year government bond yield IT10YT=RR, the benchmark for the euro area periphery, rose 5 bps to 4.40%.

The spread between Italian and German 10-year government bond yields DE10IT10=RR – a gauge of market sentiment towards the euro zone's most indebted countries – was at 175 bps after hitting its widest level in more than three months at 179.5 bps on Wednesday.

The ECB didn't provide any indication about a possible acceleration of quantitative tightening measures, which involve the central bank reducing its asset portfolio.

ECB hawks have called for ending reinvestments from bonds bought under the 1.7 trillion euro ($1.82 trillion) Pandemic Emergency Purchase Programme (PEPP) earlier than the current end-2024 deadline.

Such a move might hurt peripheral bond prices as the ECB can flexibly use PEPP reinvestments to avoid excessive yield spread widening, which might hamper the monetary policy transmission.

(Reporting by Stefano Rebaudo Editing by Mark Potter)