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Euro zone bond yields do an about-turn after U.S. inflation data

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© Reuters. FILE PHOTO: The European Central Bank (ECB) logo in Frankfurt, Germany, January 23, 2020. REUTERS/Ralph Orlowski

By Dhara Ranasinghe

LONDON (Reuters) – Government bond yields across the euro area fell to their lowest levels in almost a week on Wednesday, with investors taking comfort from signs that any tightening in European Central Bank monetary policy will be gradual.

The ECB is likely to end its bond-buying stimulus programme early in the third quarter, followed by a rate hike that could come just “a few weeks” later, ECB President Christine Lagarde said.

Several ECB policymakers have argued for a rate hike in July to contain inflation, which soared to a record high of 7.5% in the currency bloc last month.

Analysts said the tone of comments suggested a gradual rather than rapid rate-hike path, taking the edge off the aggressive rate-rise bets that drove borrowing costs across the bloc to multi-year highs as recently as Monday.

The ECB’s Francois Villeroy de Galhau said the ECB would start raising rates gradually from the summer.

“One part of the message from the ECB is that rate hikes will start in July, but the other part is that the path will be gradual, which is what Lagarde is suggesting, too,” said Jan von Gerich, chief analyst at Nordea.

“The ECB doesn’t see an active path of hiking policy like the Fed, so normalisation is going to be gradual and slower than what markets are pricing in,” he added, referring to the U.S. Federal Reserve which last week delivered a hefty half-point rate hike, with more expected in coming meetings.

Money market futures, which last week had priced in almost 100 basis points worth of ECB tightening by year-end, now price in around 85 bps — still aggressive compared to analysts’ views but suggesting a softening in expectations.

Germany’s 10-year Bund yield fell 4 bps to 0.97%. It touched its lowest in almost a week at 0.96%, moving away from almost 8-year highs hit on Monday.

Italian 10-year bond yields also hit their lowest in almost a week at 2.93% and were last down 10 bps on the day.

Another reason for the pullback in bond yields is that an increasingly bearish economic outlook has raised doubts about just how much major central banks such as the ECB can raise rates before the opportunity to do so is cut short by weakening economic growth.

The Bank of England last week warned of recession risks as it hiked rates for a fourth straight time.

“The window of opportunity for the ECB to hike rates is narrowing quite quickly in front of their eyes,” said Bethany Payne, global bonds portfolio manager at Janus Henderson Investors. “I think it’s more likely you get an earlier but less rate hikes from the ECB than what the market was pricing for.”

U.S. inflation data out later in the day could show price pressures in the world’s biggest economy are starting to abate.

Key market gauges of long-term inflation expectations in the euro area and United States have eased, with the five-year, five-year euro area breakeven inflation forward falling to a seven-week low at 2.1939%.

Euro zone bond yields, inflation expectations fall

ECB firms up expectations for July interest rate hike

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