German 10-year bond yields rise to 4-1/2-week high on inflation woes

Germany’s 10-year bond yield hit a new 4 1/2-week high on Monday, as inflation fears kept investors focused on expectations for more monetary tightening from the European Central Bank. A key gauge of long-term market euro zone inflation expectations rose to 2.207% — its highest level in over two months.

That followed fresh concern that disruption to European gas supplies will keep energy prices elevated, ensuring inflation stays high. Russia’s state energy giant Gazprom said on Friday it will halt natural gas supplies to Europe for three days at the end of the month via its main pipeline into the region. The ECB must keep raising interest rates even if a recession in Germany is increasingly likely, as inflation will stay uncomfortably high all through 2023, Bundesbank President Joachim Nagel said at the weekend.

Germany’s 10-year Bund yield rose to as high as 1.3%, its highest since July 21. It was last up 4.5 bps at 1.27% . “We expect more monetary tightening in the next few months, with a 10-year Bund yield at 1.75%,” said Francis Yard, global head of rates research at Deutsche Bank.

“Monetary policy is not even as tight as it was in 2018. Real rates are still at extremely low levels, while core inflation is around the mid-single digit,” he added. Rising U.S. Treasury yields before the Federal Reserve’s gathering this week in Jackson Hole, Wyoming added to the selling pressure in European bond markets.

British bond yields were also sharply higher on the day . Investors awaited the euro zone purchasing manager index (PMI), a closely-watched snapshot of business activity, on Tuesday and Germany’s Ifo index later in the week, for signs of recession risk that could reduce the prospects of a more aggressive ECB stance.

Italy’s 10-year bond yield was last up 8 bps at 3.57%, after hitting its highest since July 22. The spread between Italian and German 10-year government bond yields was at 229 bps, with some analysts citing political concerns ahead of the Sept. 25 Italian elections as a reason behind the recent spread widening.

Analysts worried measures to reduce taxes and increase pension spending by a right-wing government might collide with the European Union budget rules. According to the latest opinion polls, a conservative bloc is in pole position to win a parliamentary majority in the September election.

“Despite the more conciliatory attitude towards the EU compared with the 2018 election, the right’s key policy pledges have not materially changed,” Citi analysts said, citing pledges of significant tax cuts and higher pension spending. “Many (of these pledges) are likely to eventually put Italy on a collision course with Brussels,” they added.

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