Eurozone yields at top of recent range ahead of ECB meeting

Eurozone government bond yields edged lower on Friday but were still at the top end of their recent range as investors braced for a European Central Bank policy meeting tilted to the hawkish side late next week.

Analysts expect the ECB to raise rates by 25 basis points while being careful not to signal a pause in the tightening path. Such a move might lead markets to scale back their bets about future rate hikes, triggering an unwanted easing of financial conditions.

Still, they believe the ECB cannot raise rates too far as the economy is weakening, and core inflation might follow suit.

Germany’s 10-year government bond yield was down 1 basis point (bp) at 2.41%. It fluctuated between 2.25% and 2.55% since late March.

The policy-sensitive two-year yield was flat at 2.97% after trading between 2.5% and 3% in the last few weeks.

Generali Investments, which had been on the dovish side, lifted its forecast for the ECB’s terminal rate to 3.75% with a risk of even 4%.

November 2023 ECB euro short-term rate forwards were at 3.72%, implying a peak in the ECB depo rate at 3.82%.

The International Monetary Fund urged the U.S. Federal Reserve and other global central banks to “stay the course” on monetary policy and remain vigilant in combating inflation.

This week, decisions to raise rates by the Bank of Canada (BoC) and the Reserve Bank of Australia (RAB) provided upward pressure on euro area yields, but their impact was limited.

BoC’s move late on Wednesday supported Eurozone yields already rising after ECB officials’ hawkish comments.

ECB governing council member Klaas Knot said the central bank should be ready to raise rates beyond 3.75%, while ECB executive board member Isabel Schnabel warned that “the costs of doing too little (in monetary tightening) continued to be greater than the costs of doing too much.”

Bond yields ignored the RBA decision early on Tuesday and fell after an ECB survey showed consumers had lowered their inflation expectations.

Data from statistics agency Eurostat on Thursday showing the economy fell into a technical recession in the first three months of 2023 further supported expectations that the ECB won’t be able to raise rates beyond 3.75%.

Greece’s 10-year government bond yield dropped 4 bps to 3.7%, ahead of Fitch’s decision about Greek credit rating due later in the session.

The spread between Greek and German 10-year yields tightened to 125 bps, hitting its lowest level since October 2021.

Christoph Rieger, head of rates and credit research at Commerzbank, flagged in a research note that the Greek yield spread tightened to less than 30 bps over 10-year Spain.

“Considering that sovereigns usually get informed one day ahead of rating changes, this gives rise to speculation that something could be cooking tonight, although we think Fitch is more likely to wait with its investment grade rating,” he said.

Italy’s 10-year yields dropped 3 bps to 4.18%, with the spread with Germany at 176 bps while orders for Italy’s new BTP Valore bond have reached 15 billion euros, confirming strong demand from domestic retail investors. [Reuters]