German bond yields near multi-year highs on inflation fears
By Stefano Rebaudo
March 12 (Reuters) - German government bond yields were hovering around their multi-year highs on Thursday after markets boosted bets on European Central Bank rate hikes as conflict in the Middle East fuelled inflation fears.
Oil prices jumped on fears that the conflict and related oil-flow disruptions through the Strait of Hormuz would continue for an extended period.
Germany’s 10-year government bond yield DE10YT=RR was flat at 2.94%, after hitting 2.963%, its highest since October 2023.
Money markets were fully pricing a European Central Bank rate hike by July EURESTECBM4X5=ICAP, and a second increase is widely expected by December EURESTECBM7X8=ICAP.
In late February, before the outbreak of the war, traders had attached a roughly 40% chance to a rate cut from the ECB before year-end.
NO RATE HIKE EXPECTED SOON
Economists are inclined to rule out any move at next week's policy meeting, arguing that the Strait of Hormuz would need to be closed for several months to prompt ECB monetary tightening.
“The euro area is facing a new inflation shock, but that is still likely to be temporary and modest," said Holger Schmieding, chief economist at Berenberg.
"It’s a political bet, namely that Donald Trump has no interest in high petrol prices for American consumers for a long time and he will look for a way out,” he added, arguing that six months of closure of the Strait of Hormuz would turn a policy tightening in 2026 into a serious risk.
However, Wednesday's comments from policymakers fuelled expectations of a more hawkish ECB stance.
"It's not our base case scenario, but if we assume that there will be some negative (inflation) second-round effects, thinking that the ECB has to deliver one or two hikes this year is not unreasonable," said Reinhard Cluse, chief European economist at UBS.
ECB board member Isabel Schnabel said the post-pandemic spike in inflation had left scars on companies and consumers, who now knew that prices could rise fast and settle at a higher level, after policymakers promised swift action if they thought higher inflation might become entrenched.
"We stick to our assessment that the ECB will end up not raising rates this year," said Hauke Siemssen, rate strategist at Commerzbank.
"However, markets seem likely to price adverse scenarios for the time being as the hawkish talk continues to keep inflation expectations in check," he added, advising against Bund longs for now.
SPREADS WIDEN
Italy’s 10-year government bond yields IT10YT=RR rose 8.6 bps to 3.73%.
Although German bonds lost some of their safe-haven appeal, spreads edged wider when war developments hurt risk appetite.
The yield gap between Italian government bonds and Bunds widened to around 69 bps. It had been at 63 bps before the attack on Iran and hit 53.50 in mid-January, its lowest level since August 2008.
The French spread versus Bunds DE10FR10=RR was at 62 bps from 57 bps before the Middle East conflict.
