Euro zone yields rise as hopes for a quick end of tightening fade

Feb 6 (Reuters) - Euro zone government bond yields rose and spreads between core and periphery widened on Monday as investors expect central bankers to keep fighting back against expectations for a quick end of the monetary tightening cycle.

Borrowing costs plunged last Thursday as remarks from the European Central Bank, the Federal Reserve and the Bank of England fuelled hopes that the rate hiking path would be shorter than previously expected.

The day after, robust U.S. economic data and hawkish comments from ECB policymakers triggered a sharp bond sell-off driving euro area borrowing costs back up.

Germany’s 10-year government bond yield, the bloc’s benchmark, rose 5.5 basis points (bps) to 2.25%. It hit a 2-week low at 2.04% last Thursday after the ECB, while it was at 2.27% before the meeting.

The ECB euro short-term rate (ESTR) August 2023 forward was around 3.4%, implying an ECB deposit rate of 3.5% by this summer. August 2023 forward fell to about 3.25% last Thursday.

Markets will focus on comments from ECB’s Isabel Schnabel and Federal Reserve Chair Jerome Powell, due on Tuesday.

Analysts reckoned Powell could answer the question of whether a strong U.S. labour market might derail expectations that the Fed’s tightening cycle is nearing its end.

ECB’s Schnabel might clarify how much the ECB monetary policy could diverge from the Fed.

“Near-term, the focus should be back on the final leg higher in central bank rates with the market response sensitive to data surprises,” said Rainer Guntermann, strategist at Commerzbank.

“This should also keep Bunds and curves on a choppy trajectory,” he added. “The hawkish ECB bias and moderating inflation should limit the re-steepening potential, though.” Bond prices move inversely with yields.

He mentioned ECB policymakers Robert Holzmann saying rates may peak by Q3 at the latest and Bostjan Vasle arguing that “additional hikes will be needed.”

ECB Governing Council member Ignazio Visco advocated a cautious approach to monetary tightening, adding that “risk of Italian bond spread increasing will be contained as long as budgetary policies remain cautious.”

Some analysts reckoned the post-ECB bond rally was overdone, likely compounded by the dovish read on the Fed and BoE.

The Fed’s Powell referred to a “disinflationary” process that was taking hold, while BoE Governor Andrew Bailey said the BoE had “seen the first signs that inflation has turned the corner”.

However, ECB President Christine Lagarde explicitly signalled at least one more hike of the same magnitude next month and reaffirmed the central bank would “stay the course” in the fight against high inflation.

Italy’s 10-year bond yield, the benchmark for the periphery, rose 12.5 bps to 4.13%, with the closely watched spread between Italian and German 10-year yields widening to 187 bps. (Reporting by Stefano Rebaudo, Editing by Kylie MacLellan)