Euro zone bond yields fall after surging in previous session

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Euro zone government bond yields slipped on Wednesday after jumping on Tuesday as investors braced for further interest rate hikes from the European Central Bank.

The yield on Germany’s 10-year government bond, which is seen as the benchmark for the euro zone, was down 4 basis points (bps) to 2.47%. It rose 12 bps on Tuesday and touched 2.53%, just shy of its highest level since 2011. Yields move inversely to prices.

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Italy’s 10-year government bond yield wavered but was last down 3 bps to 4.593%. The gap between Italy and Germany’s 10-year yields widened slightly to 211 bps. Thin trading volumes caused yields to bounce around more than usual.

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“Yesterday, we saw quite an increase in yields, and today bonds are recovering from yesterday’s losses,” said Jan von Gerich, chief analyst at Nordea.

Euro zone bond yields have risen sharply since Dec. 15, when the ECB hiked interest rates by 50 bps and signaled that it was far from finished raising borrowing costs to tame inflation.

European governments’ plans to borrow large amounts through the bond market to support their economies next year have also caused yields to climb.

Yet euro zone yields moved lower on Wednesday, giving back some of their recent gains.

Germany’s 2-year yield, which is highly sensitive to interest rate expectations, slipped 3 bps to 2.646%. It hit its highest level since October 2008 on Tuesday, at 2.714%.

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Yields jumped on Tuesday as investors digested recent hawkish comments from ECB policymakers. On Monday, ECB policymaker and Dutch central bank chief Klaas Knot was quoted by the Financial Times as saying rates still had a way to rise.

INFLATION FIGHT

China’s decision to further loosen its COVID-19 rules also pushed up yields by causing investors to expect a stronger global economy and more persistent inflation, analysts said.

“Bond markets are still coming to terms with the faster than expected reopening of China’s economy, and with the associated increase in global demand next year,” said Antoine Bouvet, rates strategist at ING.

“Down the line, the fear for bond holders is that this will complicate central banks’ fight against inflation.”

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Investors expect the ECB to raise interest rates by 50 bps at its next meeting in early February, according to Refinitiv data. The ECB has raised its main interest rate to 2%, from -0.5% in July, in the fastest tightening cycle since the euro was created.

British government bond yields jumped on Wednesday, catching up with their European counterparts as UK markets reopened after a holiday. The 10-year UK yield was last up 5 bps to 3.687%, having earlier touched 3.761%, its highest level since late October.

Investors are uncertain about the outlook for euro zone bonds next year, as the ECB reduces its support for the market just as governments increase issuance.

Private buyers will have to buy some 400 billion euros ($425.72 billion) of additional government debt next year.

“That is a factor that may have potential to push yields higher in the coming weeks,” said Jussi Hiljanen, chief European rates strategist at SEB. ($1 = 0.9396 euros)

(Reporting by Harry Robertson Editing by Tomasz Janowski and Alison Williams)