Euro zone bonds hold steady as traders await U.S. inflation data

By Harry Robertson

LONDON, July 11 (Reuters) – Euro zone government bond yields were little changed on Tuesday, hovering at elevated levels after a sharp rise last week, as investors waited for Wednesday’s U.S. inflation data.

The yield on Germany’s 10-year bond DE10YT=RR, the euro zone’s benchmark, was last down 2 bps to 2.608%.

It rose 24 bps last week and hit a four-month high of 2.679% on Monday in a sign that investors are increasingly believing central bankers when they say interest rates are going to remain high for some time.

There was little in the way of economic data driving euro zone yields on Tuesday, analysts said. A closely watched investor sentiment survey from Germany is due later in the European morning session.

The key event this week is the release of June’s U.S. consumer price inflation (CPI) numbers tomorrow, which is likely to influence the Federal Reserve’s interest rate decision this month.

“The CPI tomorrow, probably everyone’s waiting for that, that is the key piece for the puzzle this week,” said Lyn Graham-Taylor, senior rates strategist at Rabobank.

Traders broadly expect the Fed to raise interest rates by another 25 bps to a range of between 5.25% and 5.5% on July 26.

The market thinks the European Central Bank has further to go to quell euro zone inflation. Rates are currently at 3.5% in the bloc but pricing in derivatives markets shows traders expect them to rise to a peak of 4% or more by early next year.

Expectations for higher interest rates have pushed up bond yields in recent weeks. Yields move inversely to prices.

Germany’s 2-year yield DE2YT=RR, which is highly sensitive to interest rate expectations, hit a 15-year high of 3.393% last week, rising back above where they stood before yields plunged in response to the banking crisis in mid-March.

The two-year yield was up 1 bp at 3.338% on Tuesday.

Meanwhile, Italy’s 10-year yield IT10YT=RR was unchanged at 4.364%. Investors see the bond as the benchmark for the euro zone’s more indebted countries.

The closely watched gap between Italy and Germany’s 10-year yields DE10IT10=RR widened slightly to 174 bps.

Longer-dated yields rose more than those on shorter-dated bonds last week after a long period when the opposite dynamic dominated.

Graham-Taylor said one driver of this could be “a bit of uncertainty premium because people don’t know what’s going on, so people are demanding a bit more yield on these long dates”.

Data on Tuesday showed that British wages rose at the joint highest rate on record in the three months to May, keeping the pressure on the Bank of England.

(Reporting by Harry Robertson; Editing by Christina Fincher)

((harry.robertson@thomsonreuters.com;))