Euro zone bond yields close to recent highs, focus on Fed

Aug 15 (Reuters) - Euro zone government bond yields edged higher on Monday, with investors focusing on the Federal Reserve’s next moves and weighing a potential slowdown in inflation against hawkish comments from the U.S. central bank.

Richmond Federal Reserve Bank President Thomas Barkin said on Friday he wants to raise interest rates further to bring inflation under control, despite U.S. producer prices unexpectedly falling in July amid a drop in the cost of energy products.

Germany’s 10-year government bond yield, the benchmark of the bloc, rose 1.5 basis points (bps) to 0.998%, just off its highest since July 25, hit last Friday at 1.033%.

Germany’s 2-year yields, more sensitive to central bank rate hike expectations, rose 0.5 bps to 0.615%, after briefly hitting the highest since July 22 at 0.643%.

Money markets are pricing in a 50 bps hike from the European Central Bank at its meeting in September, in addition to a slight chance of a more significant rate rise.

Risk appetite in global markets was unchanged, with equities in positive territory after China’s central bank unexpectedly cut key interest rates to support the COVID-hit economy.

Fixed income investors are waiting for minutes of the Federal Open Market Committee (FOMC) on Wednesday and the Jackson Hole symposium next week.

“The consistently hawkish Fed communication is not yet fully discounted in our view with markets looking for only 50 bp in September,” Commerzbank analysts said in a research note to clients about the ECB’s likely next move.

Italy’s 10-year government bond yield rose 3.5 bps to 3.1%, with the spread between Italian and German 10-year yields at 209 bps. It widened to more than 260 bps immediately after the collapse of Mario Draghi’s government last month.

Analysts highlighted two factors behind the recent spread tightening. The so-called first line of defence against fragmentation – Pandemic Emergency Purchase Programme (PEPP) reinvestments – showed significant support for the peripheral bond markets of Italy and Spain during July.

Additionally, Italian right-wing coalition leaders said they would stick to EU budget rules, easing some fears that the country could distance itself from the bloc. (Reporting by Stefano Rebaudo, editing by Kirsten Donovan)