Euro zone yields hit one-month high on expectations of tighter policy

LONDON, April 19 (Reuters) – Euro zone government bond yields jumped to their highest level in more than a month on Wednesday, with investors bracing for interest rates to rise further as worries about the financial system fade and policymakers called for tighter policy.

European Central Bank chief economist Philip Lane on Tuesday backed a further interest rate increase at the bank’s May policy decision but said the size would depend on incoming data.

Markets are now fully pricing in a 25 basis point rate hike at next month’s meeting, with around a 20% chance that the ECB raises rates by a larger 50 basis points.

Germany’s 10-year government bond yield, the euro area’s benchmark, hit its highest level since March 10 at 2.54%. It was last up 5 bps at 2.518%.

The country’s two-year yield, most sensitive to changes in interest rate expectations, rose 6 bps to 2.948%.

Danske Bank chief analyst Jens Peter Sørensen highlighted further signs of normalisation in the banking sector for today’s move in bonds, after Sumitomo Mitsui Financial Group became the first major bank to sell additional tier-1 (AT1) debt since similar bonds were wiped out in the takeover of Credit Suisse.

“Things are getting back to normal, we can put the banking worries behind us,” Sørensen said.

“We can now focus on fundamentals and inflation. And inflation is too high so the ECB has to do more,” Sørensen added, forecasting a peak ECB deposit rate of 4%.

Goldman Sachs raised its terminal rate forecast for the ECB to 3.75% from 3.5%, given “receding banking tensions, strong indications of underlying inflation and generally hawkish ECB commentary”.

The November 2023 ECB euro short-term rate forward stood at 3.7%, implying market expectations for the deposit facility rate to peak above 3.8%, which would be reached with three 25-basis-point rate hikes.

ECB policymakers Isabel Schnabel, Klaas Knot, Pablo Hernández de Cos and Lane are all scheduled to deliver remarks throughout the day.

“Given that worries about the banking sector have receded, they will be likely to home in on inflation and on the ECB’s appropriate response,” said Daniel Lenz, head of euro rates strategy at DZ Bank in a note.

A final reading of March euro area inflation is published at 0900 GMT, with economists polled by Reuters expecting the flash consumer prices estimate to be confirmed at 6.9%.

Italy’s 10-year government bond yield rose 6 bps to 4.35%, pushing the closely-watched spread between Italian and German 10-year yields, a gauge of confidence in the euro zone’s more indebted countries, up to around 182 bps.

Britain’s 10-year yield rose 7.5 bps after inflation fell by less than expected in March, which will likely see the Bank of England raise its key rate at its policy meeting next month.

On the supply front, Germany is set to tap its 10-year benchmark for up to four billion euros.

(Reporting by Samuel Indyk Editing by Raissa Kasolowsky)