Euro zone bond yields drift up ahead of ECB

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LONDON — Euro zone government bond yields edged up on Thursday, ahead of a European Central Bank (ECB) meeting at which policymakers are widely expected to deliver another outsized rate rise as they grapple with a slowing economy and record-breaking inflation.

The ECB is expected to raise interest rates by 75 basis points to 1.5%.

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Inflation is running at close to 10%, versus its target of 2%, and the economy faces an increasing risk of recession.

Yet, euro zone bonds are set for their biggest weekly rally in eight months, buoyed by a growing expectation that central banks around the world are reaching the end of their rate-raising cycles, even with inflation running hot.

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A media report last week that Federal Reserve policymakers could start to slow the pace of rate rises as early as December, coupled with a smaller rate increase than expected from the Bank of Canada on Wednesday have added to this perception.

Yields on the benchmark German 10-year Bund were last up 6 basis points at 2.179%. They’ve fallen by a quarter of a point in this week alone, set for their largest weekly drop since early March.

“The market is looking for a similar message and whether the ECB will give a similar message, but I don’t think they will get that. So then we could get a hawkish market reaction, at least initially,” Nordea Bank strategist Jan von Gerich said.

“The market is trading at higher yields this morning, so some of the past days’ moves are being taken back,” he said, referencing the creep higher in bond yields.

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Yields on the two-year Schatz, which is most sensitive to shifts in interest-rate expectations, rose 4 bps to 1.991%.

The regional economy is showing signs of slowdown, as households and businesses grapple with surging energy prices as a result of Russia’s war in Ukraine that has disrupted flows of natural gas, coal and crude oil.

The ECB’s inflation mandate dictates it must rein in price pressures that, in many cases including Germany, are running in double digits.

ECB President Christine Lagarde will deliver remarks and take questions at the post-decision news conference. Traders are likely to parse through her comments for any signal on the methods the central bank plans to use to tighten credit conditions to tame inflation.

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“Lagarde has already said that ’75 is not the norm’ in the previous Q&A, hence a repetition of this statement should not be seen as dovish,” Deutsche Bank strategists led by Ioannis Sokos said in a note.

Quantitative tightening, whereby the ECB sells its holdings of government bonds back into the market to absorb extra cash, is one of those means. Policymakers have recently made the case for running down the central bank’s massive balance sheet that boasts more than 5 trillion euros’ ($5.03 trillion) worth of bonds.

Another means the ECB has at its disposal is discouraging commercial banks from hanging on to funds acquired via its Targeted Longer-Term Refinancing Operations (TLTROs) at super-low, or even negative, rates.

Now that rates have risen, the central bank is pushing lenders to repay that funding sooner rather than later.

Yields on Italian 10-year debt, which tends to serve as a proxy for the more heavily indebted euro zone members, rose 1 bp to 4.341%. ($1 = 0.9936 euros) (Editing by Alex Richardson)