Euro zone short-term government bond yields rose on Friday but failed to recoup all losses on Thursday as money markets lowered their interest rate hike expectations after the European Central Bank (ECB ) eased its pace of tightening.
All ECB policy makers, with the exception of Austrian Robert Holzmann, supported the 0.25 percentage point increase in the ECB’s main interest rate to 3.25%, which follows an unprecedented series of increases of 0, 75 and 0.50 percentage points since last July.
Money markets are currently pricing in fewer than two 0.25 percentage point rate hikes through the autumn as investors believe the ECB could take a break from its key 3.5% rate if inflation data may surprise in the negative.
The yield on 10-year German government bonds, the euro zone’s benchmark index, climbed 0.06 percentage points to 2.25%, after falling 0.055 percentage points the day before.
The German 2-year yield, more sensitive to interest rate expectations, climbed 0.05 percentage points to 2.58%, after falling 0.145 percentage points the day before.
The yield on Italian 10-year government bonds rose 0.06 pp to 4.18%, with the spread between Italian and German 10-year yields, a measure of investor sentiment towards the most indebted eurozone countries, at 1.91pp
The ECB’s short-term forward rate for September was at 3.56%, implying expectations of a deposit rate of 3.66% in the autumn. June forward was 3.35%, not fully pricing in a 0.25pp rate hike
Money markets were pricing in a maximum deposit rate of around 3.75% ahead of the ECB policy meeting.
ECB policymaker François Villeroy de Galhau said on Friday that “the gist of the effort (in terms of raising rates) has been made” and the change in the pace of rate hikes was an important signal.
However, ECB rates will need to hike further, Lithuanian politician Gediminas Simkus said on Friday.
Barclays expects two more increases of 0.25 percentage points
The ECB has announced it will stop reinvesting money from maturing bonds purchased under its €3.2 trillion asset purchase program (APP) from July.
Analysts estimate that the ECB’s balance sheet is contracting by an average of around 25 billion euros a month.
However, “the final point means that the ECB can no longer facilitate reinvestments. In July, the run-off reaches more than 30 billion and in October more than 50 billion,” said Christoph Rieger, head of interest rate research at Commerzbank .
“While the ECB could still use flexible PEPP reinvestments to prop up the periphery, tensions will have to escalate, meaning markets could get nervous,” he added.
Some analysts said the impact of the ECB halting bond reinvestment should be limited, as issuers in the eurozone have already sold off much of this year’s expected net supply of bonds.
Source: Terra

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