Euro zone bond yields jump as ECB seen mulling 50 bps July rate hike

Euro zone government bond yields shot higher on Tuesday following a source-based report that the European Central Bank would discuss whether to raise rates by 25 or 50 basis points when it meets on Thursday.

The ECB has flagged that it would raise rates by 25 bps at the July policy meeting to contain record high inflation, so news that it could mull a bigger move came as somewhat of a surprise to markets.

Money markets now price in roughly a 60% chance of a 50 bps rate hike this week, up from around 35% on Monday.

“It would be surprising if they go for a 50 bps hike because the signalling from the majority of policymakers has been for a 25 bps move,” said Nordea chief analyst Jan von Gerich.

“Given how far they have gone to hold onto their forward guidance, it would be difficult to break from that for now.”

Investors appeared not to want to take any chances and the sharp selloff in bond markets suggested they were now positioning for a bigger ECB rate move.

Germany’s two-year bond yield, sensitive to near-term rate expectations, climbed around 10 bps to its highest in over two weeks at around 0.64%.

Across the euro area, benchmark 10-year bond yields were around 5 bps higher on the day.

The euro, which last week fell below parity against the dollar for the first time in two decades, was trading 1% higher at $1.0244.

A rate rise from the ECB this week would mark its first rate increase since 2011 and follows aggressive moves by other major central banks recently to get on top of red-hot inflation.

According to the source-based story published by Reuters, policymakers were also homing in on a deal to provide help for indebted countries like Italy on bond markets if they stick to European Commission rules on reforms and budget discipline.

Analysts said that deploying a new tool has been complicated by a new political crisis in Italy that has put upward pressure on the country’s borrowing costs.

Italy’s 10-year bond yield was last up 4 bps at around 3.43%.

Prime Minister Mario Draghi is expected to address parliament on Wednesday. Draghi tendered his resignation last week after the populist 5-Star Movement refused to back the government in a confidence vote at the Senate. That resignation was rejected by President Sergio Mattarella and it is still unclear whether Draghi will change his mind.

“There needs to be more carnage in Italian bonds before the ECB takes action,” said von Gerich.