Euro zone spreads hit fresh highs amid rising yields

By Stefano Rebaudo

MILAN (Reuters) – Euro zone government bond yields hit fresh multi-year highs on Tuesday while spreads between core and periphery widened amid concerns about accelerated central bank monetary tightening. Yield spreads have been widening since Thursday’s European Central Bank policy meeting when the bank flagged interest rate hikes to contain high inflation but said it saw no need to create a new tool to help weaker economies cope with rising borrowing costs. Italy’s 10-year government bond yield rose 4.5 basis points (bps) after hitting its highest since December 2013 at 4.204%. The Italian-German spread – a gauge of the euro area financial stability – hit its widest level since April 2020 at 252.9 bps.. Spanish and Portuguese spreads have hit their highest since May 2020. “Spreads are widening as markets want to see which levels might trigger an ECB reaction,” said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors. At 1700 GMT, ECB board member Isabel Schnabel will speak about euro area bond market fragmentation — an excessive spread widening that might endanger the transmission of monetary policy across the euro area. Citi analysts argued that Schnabel’s speech was likely to disappoint the market, while they upgraded their target for the Italian-German yield spread to 275 bps. Investors remained on edge, although a recent bond selloff slowed down on Tuesday ahead of the outcome of a U.S. Federal Reserve policy meeting due late on Wednesday.

Germany’s 10-year government bond yield, the benchmark of the bloc, rose 4.5 bps to its highest since April 2014 at 1.688%

Germany and Italy were in the primary market with auctions on Tuesday.

German investor sentiment rose slightly in June, roughly in line with market expectations, as financial market experts were less pessimistic about the economy, though it remained in negative territory due to numerous risks.

Money markets are currently pricing in 175 bps of ECB rate hikes by year-end, including almost 90 bps by September, from around 170 bps on Monday.

Economists argued that market forecasts for rate hikes might be excessive, because investors rushing to hedge their loan portfolios enlarges what is priced in.

“We regard the most recent pricing developments as an exaggeration,” Unicredit analysts said, mentioning market expectations for the peak of the ECB’s rate-hike cycle of 2.5%.

Investors will look at other central banks’ policy meetings due this week, including the Bank of England, which has raised rates but is facing an economic slowdown.

The National Swiss Bank and the Bank of Japan will also be in focus as some analysts argue that any unexpected hawkish shift might favour a new global bond selloff.

(Reporting by Stefano Rebaudo; editing by Susan Fenton)