Rise in European bond yields thanks to progressive bets from the ECB

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European government bonds fell on investors’ bets that rising inflation could prompt the European Central Bank to weigh on reducing stimulus measures.

The 10-year German Bund yield edged up Wednesday to minus 0.369%, the highest since mid-July, from an August low of minus 0.502%. The yield on Italian benchmark bonds reached 0.730% from last month’s low of 0.513%, before falling moderately.

Investors are betting that as the region’s economic outlook improves, the central bank will reduce its purchases of government bonds with a program designed to strengthen credit markets and growth during the pandemic.

“We could see tapering talk coming from the ECB,” said James Athey, investment manager at Aberdeen Standard Investments. The extension of the emergency purchase program in the event of a pandemic “is difficult to justify when growth is strong, inflation high and unemployment falling,” he added.

Growth and inflation are showing signs of recovery in the euro area. A preliminary gauge of the consumer price index in August hit 3%, beating economists’ expectations. Core inflation hit 1.6%, highest since July 2012, Deutsche Bank says.

New data released on Wednesday also showed that unemployment in the euro area also fell slightly in July.

Mr Athey is betting on a massive sell-off of Italian and French government bonds in anticipation of the ECB’s reduction in its asset purchases.

Bank stocks also rose, pushing the Stoxx Europe 600 banks sub-index up 0.9% on Wednesday, while the wider pan-continental gauge climbed 0.5%. Longer-dated bond yields are considered an indicator of future interest rates, which is a key factor in bank profitability.

Klaas Knot and Robert Holzmann, two ECB policymakers, said on Tuesday that the eurozone economy and inflation outlook have recovered enough for the central bank to slow the pace of its bond purchases. Investors are awaiting further signals after next week’s monetary policy meeting.

“There are increasing calls within the ECB to slow down its support for the crisis. We expect the first step in this direction to be taken at next week’s meeting, ”said Rohan Khanna, rate strategist at UBS.

Mr Khanna said he expects the ECB to slow down the pace of purchases in the fourth quarter.

The central bank has been a voracious buyer since the Covid-19 pandemic crippled the global economy in the spring of last year. The ECB took back all government bonds issued in 2020, a trend that has continued this year so far, according to UBS. But the net supply of European government bonds may no longer be negative in 2022, Khanna said.

A slowdown in ECB purchases would likely follow a similar move by the Federal Reserve. At the Jackson Hole Symposium last week, Fed Chairman Jerome Powell reiterated that the U.S. central bank is likely to start cutting its bond buying program by the end of the year.

Analysts said the start of September also traditionally means an increase in bond issuance, as fund managers and bankers return to the office after the summer recess. It also pushes up yields, says Bank of America rate strategist Ralf Preusser.

The surprising pick-up in inflation is also giving ammunition to ECB policymakers calling for a slowdown in support, Mr Preusser said. “The market must now integrate the risk of cost reduction. “

Write to Anna Hirtenstein at [email protected]

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