By Stefano Rebaudo
(Reuters) -German bond yields rose on Thursday after European Central Bank board member Isabel Schnabel fuelled inflation concerns by saying consumer prices could still accelerate in the short term.
The inflation outlook for the bloc, where prices rose more than expected to another record high in July, has failed to improve since a rate hike last month, Schnabel said, suggesting she favoured another large interest rate increase next month.
The bloc’s borrowing costs jumped on Wednesday on inflation fears after British price growth hit double digits, shifting investors’ focus away from recession risks that could slow monetary tightening.
By 1440 GMT, Germany’s 10-year government bond yield, the benchmark for the bloc, was up 2 basis points (bps) to 1.097%, after hitting an almost four-week high of 1.15% in earlier trade.
In mid-June it reached its highest level since 2014 at 1.926%, before falling to 0.678% on Aug. 2 as investors scaled back their expectations for ECB rate hikes.
Money markets are currently fully pricing in a 50 bps ECB move in September and a 40% chance of an additional 25 bps, according to Refinitiv data.
“Swap spreads are rich and are already pricing in significantly more monetary tightening compared to just looking at Bund yields,” said James Ringer, fund manager at Schroders.
“But weak PMI data on Tuesday (next week) showing a deterioration of economic growth, might cap a further yield rise,” he added.
Moves in euro zone bonds were in contrast to U.S. Treasuries, where yields fell on Thursday.
Minutes of the last Fed meeting released on Wednesday showed U.S. central bank policymakers were committed to raising rates to tame inflation – even as they began to acknowledge the risk that they might go too far and curb economic activity too much.
Italy’s 10-year government bond (BTP) yield was last up 1.5 bps to 3.33%, after hitting its highest since July 28 at 3.374%, with the spread between Italian and German 10-year bond (Bund) yields at 222 bps.
The BTP-Bund spread has widened by 15 bps over the last two sessions, in a move likely to have been exacerbated by thin August liquidity.
Citi analysts suggested various drivers behind 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.
The so-called first line of defence against fragmentation – PEPP reinvestments – showed significant support for the bond markets of Italy and Spain in July as the ECB skewed reinvestments to these jurisdictions.
Citi analysts said they forecast Italy’s net cash requirement after accounting for coupons, redemptions and ECB flows would be flat in September after faring at negative 16 billion euros and negative 14 billion euros respectively over the last two months.
(Reporting by Stefano Rebaudo, additional reporting by Yoruk Bahceli; Editing by Catherine Evans and Alex Richardson)