Euro zone yields jump as bets on Dec ’22 ECB hike resume

Euro zone bond yields jumped and Southern European bonds underperformed on Tuesday as investors ramped up their bets on a European Central Bank rate hike next year as the bank’s policymakers cast attention to upside inflation risks.

Euro zone inflation would be higher next year than previously thought and could stay above the ECB’s target in the medium term, board member Isabel Schnabel said on Tuesday. Ending the PEPP purchases remains a valid plan despite the new coronavirus wave, she added.

ECB policymaker Klaas Knot, also head of the Dutch central bank, said the inflation outlook is expected to be closer to the bank’s 2% goal than pre-pandemic, justifying a reduction in monetary stimulus.

The comments followed French central bank governor Francois Villeroy de Galhau, who late on Monday said that increasing the bank’s conventional bond purchases once its pandemic emergency bond purchases (PEPP) expire next March was a possibility, but was not needed right now.

Antoine Bouvet, senior rates strategist at ING, said euro zone bond yields were rising because “the message is that the ECB is increasingly focused on inflation upside, that it is not going to change its plan to end PEPP in March, and is in no rush to boost the (asset purchase programme) after that”.

Tuesday’s comments also prompted money markets to resume betting on a full 10 basis point hike from the ECB by December 2022, having seen a 50% chance of such a move on just Monday.

Southern European states, the biggest beneficiaries of ECB stimulus, led the rise in yields. Italy’s 10-year yield was up 8 bps to 1.02% by 0925 GMT, rising above 1% for the first time in nearly a week and adding to an 8 bps rise on Monday driven in part by Villeroy’s comments.

The closely watched risk premium it pays over German peers rose to 126 bps.

The region’s bonds came under particular pressure as they face a stability test as the PEPP expires. The conventional purchases are governed by stricter rules on how much of each country’s debt the ECB can buy. [nL1N2SDOEU]

Beyond PEPP, the ECB maintains that it will end its asset purchases shortly before it hikes rates, so bets on rate hikes also exacerbate pressure on the bonds, a concern that sent Southern European yields surging in late October.

After rising 5 bps on Monday, Germany’s 10-year yield, the benchmark for the euro area, was up 4 bps to -0.25%.

Yields also rose after November business activity data for the euro area surprised to the upside, accelerating rather than slowing as a Reuters poll had expected, with consumers shrugging off another wave of coronavirus infections and new restrictions. [nZRN003EPM]

The nomination of chairman Jerome Powell to a second term leading the U.S. Federal Reserve has also pushed rates higher and saw investors bring forward their bets on a Fed rate hike next year.