Euro area bond yields rise with inflation concerns in focus

LONDON: Euro area sovereign bond yields rose on Monday after European Central Bank officials reiterated monetary policy needed to remain restrictive and it was too early to declare victory over rising prices. Inflation remains far too high, so monetary policy needs to restrict economic output for the foreseeable future, ECB policy hawk Joachim Nagel said on Saturday.

The euro zone labour market shows no sign of softening, despite a near-recessionary environment and a record string of interest rate hikes, ECB President Christine Lagarde said. Germany's 10-year bond yield, the benchmark for the euro area, rose 5 basis points (bps) to 2.78%.

A rush into safe-haven assets had driven the Bund yield down from around 2.9% on Oct. 6 to about 2.7% in a few days on concerns about the conflict in the Middle East. Top U.S. officials warned on Sunday that the war between Israel and the militant group Hamas could escalate into a wider conflict across the Middle East.

Inflation concerns propped up bond yields as oil prices jumped. Brent futures slipped on Monday after surging last week as investors wait to see if the Israel-Hamas conflict draws in other countries - a development that would potentially drive up prices further. Italy's 10-year yield – the benchmark for the euro area's periphery – rose 1 bp to 4.767%.

The spread between Italian and German 10-year yields – a gauge of investors' confidence towards the euro zone's most indebted countries – was at 197 bps. On Oct. 9, it hit 209.2 bps, its highest level in over 10 months. Investors expect strong demand for bonds coupled with an ECB backstop – the Transmission Protection Instrument (TPI) the central bank approved in July 2022 to prevent disorderly market dynamics - to keep peripheral bond yields well-behaved.

However, some analysts see a further widening from the current levels. "Unless ECB comments turn more attentive, BTP spreads could test further upside," said Rainer Guntermann rate strategist at Commerzbank.

On Monday, Italy's government approved a budget with measures worth around 24 billion euros. Under the plans, the deficit will rise to 4.3% of gross domestic product next year. Italian central bank governor Ignazio Visco said on Friday the spread differential with German bonds is "relevant" but is far from the 2011 levels when the euro zone was facing a crisis.

"There are no signs, really, that it should rise, really, in a territory... which would require us to intervene. But if there was a need, I think we can," Visco argued. The cost of insuring five-year Italian debt against the risk of default held at 115 basis points at Monday's close, unchanged from levels earlier in the day and also unchanged from Friday, according to data from S&P Global Market Intelligence.