Bund yields rise as investors closely watch German political developments

By Stefano Rebaudo

March 11 (Reuters) - Euro area benchmark Bund yields edged higher as investors monitored German political developments to assess the size and timing of a planned massive increase in fiscal spending.

Germany's Greens vowed to block plans by likely next chancellor Friedrich Merz to raise state borrowing to revamp the military and revive growth but forwarded rival proposals on Monday in a bid for compromise.

"If the old parliament does not pass the immediate fiscal reform, or if the constitutional court gets in the way, Germany could still grant itself more fiscal space fast," said Holger Schmieding, chief economist at Berenberg.

"In that case, we would expect the new government to invoke the emergency clause of the debt brake once Merz has been elected as chancellor, probably at some time in April."

Bund yields DE10YT=RR were up 4 basis points (bps) at 2.87%. They jumped by 44.7 bps last week, their biggest rise since February 1990, when they hit 2.929%, its highest level since October 2023.

"The last few days have reminded me of someone borrowing lots of money to buy a highly sophisticated sports car, getting into the car, starting the engine with a vroom, but then killing the engine seconds later," said Carsten Brzeski, global head of macro at ING, referring to German politics.

"A cringe moment indeed, but the sports car could still be re-started and speed away."

A senior ally of Merz was optimistic about securing support for a massive increase in state borrowing this month.

Investors recently scaled back their bets on future European Central Bank rate cuts as they expected the fiscal shift in Germany to boost the euro area economy.

Traders priced in an ECB deposit facility rate of 2.05% in December EURESTECBM6X7=ICAP from 1.92% last week before the Germany's announcement.

They also price an around 50% chance of an easing move in April, while the debate among ECB officials is heating up.

There are still plenty of upside risks to inflation, so the ECB must remain open-minded on whether to press ahead with interest rate cuts or pause them, Slovak central bank Governor Peter Kazimir said on Monday.

ECB policymaker Mario Centeno said on Friday inflation was "almost out of the woods".

Germany's 2-year yield DE2YT=RR, more sensitive to ECB policy rates, rose one bp to 2.23%.

The yield gap between Italian and German bonds DE10IT10=RR - a market gauge of the risk premium investors demand to hold Italian debt – was at 104 bps after dropping below 100 bps for the first time since 2021 last week.

The spread between French and German bonds DE10FR10=RR stood at 69 bps, at the lower end of its recent range.