European Bonds Plagued by Inflation Set for Record Annual Loss


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(Bloomberg) — European bonds tumbled, extending their worst year on record, as signs of persistent inflation rekindled concern over how much further the central bank will have to raise interest rates.

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German 10- and five-year yields rose to fresh eleven-year highs, while risk-sensitive Italian bonds underperformed. Data Friday showed headline Spanish inflation slowed in December, but a gauge of underlying price increases accelerated to 6.9%, the highest since 2002.

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The prospect of tighter monetary policy has bruised fixed-income markets this year, with a Bloomberg index of euro-denominated investment-grade debt down more than 16% in 2022, the biggest loss in data going back to 1998. 

Investors remain wary that policy makers will have to raise rates more aggressively to bring inflation in the region back to their 2% target. Keeping the European Central Bank’s key rate at a restrictive level would reduce inflation over time, Governing Council member Yannis Stournaras said in an op-ed for the Greek Parapolitika newspaper.  

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Traders added to their rate-hike wagers, betting the ECB will lift its key rate to as high as 3.59% by mid 2023. The yield on 10-year German bonds rose as much as 11 basis points to 2.55%. The five-year yield jumped 10 basis points to 2.56%.

The ECB is also expected to start shrinking its balance sheet in March, putting an end to years of accommodative monetary policy that has kept a lid on borrowing costs. That’s just as governments are set to ramp up bond issuance to fund programs designed to shield the region from an energy crisis.

—With assistance from Libby Cherry.

(Updates prices, adds ECB comment in the fourth paragraph.)


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