Eurozone short-dated yields near highest in over a decade

EUROZONE borrowing costs edged higher on Monday (Dec 19), with the short-dated yields near their highest levels in more than a decade, as investors were concerned about a hawkish European Central Bank (ECB) and increasing bond supply.

Analysts said more public spending to fight the adverse impact of the energy crisis might raise the 10-year Bund yield to as high as 2.7 per cent in 2023. This would be due to increased government funding needs, amid a drop in excess liquidity.

The ECB pledged further rate hikes to fight inflation, but it also announced that it would start reducing its five trillion euro bond holdings from March next year.

Germany’s 10-year government bond yield, the bloc’s benchmark, rose 2.5 basis points (bps) to 2.2 per cent. The German two-year yield, most sensitive to changes in policy rates, dropped 1.5 bps to 2.4 per cent. On Friday, it reached its highest since November 2008, at 2.5 per cent.

The German yield curve was inverted, with the gap between two-year and 10-year yields at minus 24 bps. It briefly hit a fresh 30-year low at minus 41.9 bps last Friday.

An inversion suggests that investors expect the ECB to pause its hikes or even cut rates in the future, as inflation will start declining faster than expected, or because the central bank wants to avoid deepening a recession.

The likelihood of a recession in Germany fell with the release of a survey on Monday, showing a stronger-than-expected rise in business morale in Europe’s largest economy in December.

The ECB’s hawkish comments and strong economic data from Germany propped up eurozone yields. The bank’s Slovak policymaker Peter Kazimir said that interest rates would not only need to go into restrictive territory, but also stay there longer.

Italy’s two-year yield was up 1 bps at 3.1 per cent. On Sep 28, it hit its peak since August 2012, at 3.4 per cent. The 10-year government bond yield rose 6 bps to 4.4 per cent, with the closely-watched spread between Italian and German 10-year yields widening to 216 bps.

SEE ALSO

ECB’s de Guindos says changing inflation goal will hurt credibility

Global recession risks rise as central banks raise rates

ECB bars policymakers from speculating after backlash, Fed scandals

Europe: Shares post worst weekly loss since September as recession fears mount

More

ECB euro short-term rates (ESTR) forward for September 2023 were at around 3.3 per cent.

The Bank of America saw a terminal deposit rate at 3.50 per cent, with a 50 bps rate hike in February and March next year, and two more 25 bps hikes in May and June.

Ruben Segura-Cayuela, the bank’s Europe economist, said: “The big picture remains the same: we think the ECB is at serious risk of overdoing the tightening and ending up destroying more demand than is necessary to bring inflation back to target.”

Commerzbank rates strategist Rainer Guntermann said: “With recent events fuelling bearish rates and quantitative tightening (QT) expectations, the backdrop for long-end supply over the first weeks of the new year looks set to become even more challenging.”

The ECB said it would start reducing its large holdings of government debt, in a move often called quantitative tightening, from March next year.

Some analysts said they expect reinvestments to stop entirely after June, although the emergence of stress on peripheral sovereign debt might change this view. REUTERS