Euro zone yields hit multi-week lows amid mixed signals on inflation

BY Reuters | ECONOMIC | 12/07/22 07:00 AM EST

By Stefano Rebaudo

Dec 7 (Reuters) - Euro zone government bond yields hit fresh multi-week lows in a volatile session on Wednesday amid conflicting signals about when inflation will peak.

An ECB survey showed rising inflation expectations for the year ahead but for three years out it held steady at a rate well above the European Central Bank's (ECB) 2% target.

However, ECB chief economist Philip Lane had argued on Tuesday a peak in inflation was probably close.

Germany's 10-year bond yield was down 2 basis points (bps) at 1.78% by 1541 GMT. It touched its lowest since Sept. 19 at 1.75% in early trade.

The 2-year yield fell 5.5 bps to 2.00%.

"The strong pricing and demand at yesterday's Schatz tap add to the notion of overriding demand for Bunds in anticipation of peaking terminal rate expectations," Commerzbank analysts said.

The German Finance Agency sold 4.015 billion euros in a top-up of its 2.20%, two-year Schatz notes at the lowest price of 100.17, with an average yield of 2.1%.

Forwards on ECB Euro short-term rate priced a peak in policy rates in June 2023 at around 2.75% on Wednesday from a peak in August 2023 at around 2.9% at the end of November.

Italy's 10-year government bond yield was down 4.5 bps at 3.62% after hitting its lowest since Aug. 26 at 3.58%.

The spread between Italian and German 10-year bond yields tightened to 183 bps, after data on Pandemic Emergency Purchase Programme (PEPP) reinvestments. It hit its tightest since April 28 at 177.2 on Nov. 28.

The ECB cut holdings under its PEPP of southern European nations' bonds over the last two months, picking up German and Dutch debt instead, a bimonthly disclosure showed on Tuesday.

The ECB stopped buying new bonds under the PEPP earlier this year and said it would exercise "flexibility" when reinvesting cash from maturing debt, allowing it to help individual euro zone members should their borrowing costs rise too much.

"That (recent) tightening (between core and peripheral yield spreads) cannot be entirely explained by the rally in core rates and suggests instead genuine risk appetite for high beta fixed income," ING analysts said.

Some investors said recently that more attractive peripheral yields and a European Central Bank backstop could rein in the risk premium for Southern European debt.

Analysts said the lesson from the last five months of PEPP reinvestment data is that flexibility will remain a backstop for significant spread volatility episodes. Still, the ECB will use it sparingly and to the extent needed.

(Reporting by Stefano Rebaudo; Editing by Toby Chopra, Arun Koyyur, Kirsten Donovan)

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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