Euro zone bond yields up as rally takes a breather

BY Reuters | TREASURY | 01/05/23 07:03 AM EST

By Samuel Indyk

LONDON, Jan 5 (Reuters) - This week's rally in euro zone government bonds petered out on Thursday, as heavy government bond supply added to pressure on prices which were also influenced by a move higher in U.S. Treasury yields.

Germany's 10-year government bond yield, the benchmark for the bloc, rose 4.6 basis points (bp) to 2.32%, though still remained 23 bps lower on the week.

Yields move inversely with prices, and the German 10 year yield closed 2022 at its highest level since 2011.

The yield decline early in the week was driven by preliminary inflation data released from Germany, France and Spain which showed consumer prices rose at a slower pace in December than November, following an easing in energy price rises.

Annual harmonised consumer prices in Italy, the 20-nation euro area's third largest economy, slowed to 12.3% in December from 12.6%, matching expectations, according to Thursday data.

"There's been a bullish start to the year, given the inflation numbers below expectations," said Daniel Lenz, rates strategist at DZ Bank, adding that there's hope in the market that the peak in inflation may have been reached.

"It's not a big surprise to see markets taking a breather," Lenz added.

Germany's 2-year yield, which is sensitive to changes in interest rate expectations, was up 6 bps to 2.65%.

Thursday's focus was on a heavy supply pipeline, with France selling a total of 12 billion euros of longer-dated debt.

Portugal, Ireland and the European Investment Bank are also selling new syndicated long-end debt via syndication.

"There's a bulk of supply and demand is high, but most of the issuers seem to be eager to come to market with a lot of new bonds at the beginning of the year," DZ Bank's Lenz added. "This puts pressure on the market."

Euro zone government bond issuance is set to balloon this year as governments across the bloc raise funds in an attempt to soften the blows from soaring energy prices.

The European Central Bank is also scheduled to start offloading its holdings of government debt, known as quantitative tightening (QT), which could further keep bond prices under pressure in 2023.

Another factor in markets Thursday was U.S. data showing the labour market in the world's largest economy remained tight, suggesting the Federal Reserve will keep interest rates higher for some time.

That sent U.S. yields higher, with the benchmark 10 year Treasury yield up 3 basis points to 3.74%, also dragging a little on European bonds.

Minutes from the Federal Reserve's December meeting released on Wednesday showed policymakers remain committed to raising rates to cool inflation, even as they slowed their pace of tightening last month.

In Europe, Italy's 10 year yield was 7 basis points higher at 4.33% and the two year yield was up 0.4% at 3.11%. (Reporting by Samuel Indyk, additional reporting by Alun John; Editing by Alex Richardson, Elaine Hardcastle)

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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.

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