Euro zone government bond yields jumped on Thursday after strong German inflation data fueled expectations for a quicker pace of monetary tightening by the European Central Bank.
German annual inflation rose 7.8%, slightly more than expected in April due to energy prices and delivery bottlenecks caused by supply chain interruptions.
“Markets are very sensitive to inflation data; even numbers slightly above expectations trigger speculation about a more hawkish central bank,” ING rates strategist Antoine Bouvet said.
Germany’s 10-year government bond yield, the bloc’s benchmark, rose 10 basis points (bps) to 0.902%, heading closer to a seven-year high of 0.974% touched on Monday.
Money markets’ expectations for an ECB rate hike inched higher, now pricing in around 85 bps rate hikes by year-end, from 80 bps before the German data.
Supporting those expectations, European Central Bank president Christine Lagarde was quoted as saying on Wednesday that quantitative easing will end “in all likelihood early in the third quarter, probably in July” and that would be the time to “look at interest rates and an increase in those rates.”
In the meantime, Italy’s 10-year yield rose 16 bps to its highest since March 2020 to 2.740%, with the yield gap over benchmark German bonds at 183 bps.
Analysts expected spreads between peripheral and core euro zone bond yields to widen as hopes for additional fiscal and monetary support for indebted Southern European countries faded. The Italian/German spread could rise to as high as around 190 bps by year-end, according to analysts .
ECB Vice President Luis De Guindos said the central bank could act on a potential unwarranted widening of the spreads between the debt instruments of the bloc’s core and periphery.
“We have not any discussed concrete instruments… but I can assure you that we are ready to act,” he said.
In contrast to German inflation, Spanish consumer prices slowed for the first time since January to 8.4% and undershot a forecast of 9% by analysts.
“The impact of a slowdown in demand is starting to kick in some countries, affecting consumer prices, but I think we don’t have a clear medium term trend of the eurozone inflation yet,” said Andreas Billmeier, European economist at the Western Asset part of Franklin Templeton.
But growth concerns continued to loom on markets amid COVID lockdowns in China, an unexpected contraction of the US economy in the first quarter and uncertainty about the economic fallout of the Ukraine war – with Russia halting gas supply to Poland and Bulgaria on Wednesday.
ECB’s De Guindos said the central bank needed to keep a close eye on a recent rise in bets inflation will rise above its 2% target.
A key gauge of euro zone long-term inflation expectations held near a 10-year high at 2.5%.
(Reporting by Stefano Rebaudo, additional reporting by Joice Alves and Dhara Ranasinghe; Editing by Bernadette Baum)