(Reuters) -Germany’s 10-year government bond yield rose to a fresh eight-week high on Wednesday as inflation fears reinforced expectations for an aggressive European Central Bank (ECB) monetary tightening path.
Analysts expect the ECB to raise interest rates to tame inflation — which they forecast will stay uncomfortably high through 2023 — even if a recession is increasingly likely.
Recession fears amid surging energy prices and the rate implications were also behind a surge in British short-dated government bond yields, which hit fresh 14-year highs on Wednesday.
Borrowing costs rose on Tuesday after a Purchasing Managers’ Index (PMI) survey showed that business activity contracted for a second straight month in August.
“Euro zone yields have room to rise as central banks have to deal with inflation first, despite recession risks,” said Kaspar Hense, senior portfolio manager at BlueBay Asset Management.
“We expect the 10-year Bund yield to top out at around 1.5% with a yield curve inverted and Italian rates at 4%,” he added.
Germany’s 10-year government bond yield rose 6 basis points (bps) to 1.382%, earlier hitting its highest level since July 1 at 1.390%.
Dutch wholesale gas prices, which are currently the main driver of inflation expectations, rose 11.15% to 289.00 euros per megawatt-hour (MWh) on Wednesday after falling the day before.
They hit their highest since March at 292.5 on Monday as market players remain concerned over a possible halt to the main Russian pipeline to Germany.
“Higher energy prices are driving bets that policy rates will have to be increased much more than previously thought, which I think is a questionable assumption given the looming recession in Europe,” said Antoine Bouvet, senior rates strategist at ING.
Investors are now awaiting the release of minutes to the ECB’s last policy meeting and the German Ifo business due on Thursday.
Money markets kept fully pricing a 50 bps rate hike in September and around 200 bps by September 2023.
Italy’s 10-year yield rose 7 bps to 3.708%, after hitting a fresh five-week high of 3.748%, with the spread between Italian and German yields at 233 bps.
Analysts suggested various drivers behind the recent spread widening, including limited reinvestment flexibility in August for the ECB’s pandemic bond programme redemptions, given no core or semi-core government bonds redemptions and a deteriorating net supply backdrop in September.
Citi analysts recently argued that right-wing parties’ pledges of significant tax cuts and higher pension spending might eventually put Italy on a collision course with Brussels.
According to the latest opinion polls, a conservative bloc will win a parliamentary majority in the Italian elections due on Sept. 25.
(Reporting by Stefano Rebaudo; additional reporting by Lucy Raitano, editing by Shri Navaratnam and Emelia Sithole-Matarise)