Eurozone rates jump, Italy-Germany spread narrows after ECB remarks

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Eurozone government bond yields rose on Tuesday as investors focused on inflation risks, while spreads between core and periphery countries tightened as the European Central Bank reiterated that its anti-fragmentation tool should have no limits.

The ECB announced plans in mid-June to tackle fragmentation in eurozone bond markets, or an excessive widening of spreads between core and peripheral yields that could hamper the transmission of monetary policy across the bloc.

ECB policymaker Pierre Wunsch said on Tuesday the bank should offer unlimited support to euro zone members facing unjustified increases in borrowing costs.

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ECB President Christine Lagarde said she would act decisively on any deterioration in the medium-term inflation outlook, while controlling any disorderly widening of spreads.

The ECB must strike a balance between the need to control inflation and the risk of triggering a recession.

Analysts say there are too many worries about inflation and not enough about a potential recession to end the bond bear market, pending euro zone inflation data later this week.

Oil rose $1.9 a barrel as Group of Seven countries pledged a potential cap on Russian oil and gas prices that would hit Russian President Vladimir Putin’s war chest.

The yield on Germany’s 10-year government bond, the eurozone benchmark, rose 10 basis points (bps) to 1.64%, after hitting a nearly week-long high at 1.673%.

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“It’s potentially an interesting week as we’ll see if central bankers intend to tone down their hawkish tone while also focusing on growth risks,” said Andrew Mulliner, head of global global strategies at Janus Henderson, mentioning this week’s inflation data.

Germany will release consumer price data on Wednesday, while Eurozone data is due on Friday.

Several policymakers will speak at the ECB Central Banking Forum 2022 in Sintra, Portugal on Tuesday and Wednesday.

New York Federal Reserve Chairman John Williams has called for further rapid U.S. interest rate hikes to curb inflation, including a possible second rate hike of 75 basis points next month, but said he did not expect a US recession.

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“A credible anti-fragmentation tool would allow the ECB to steepen its monetary tightening path, and then we would expect yields to rise,” said Hetal Mehta, senior European economist at Legal and General Investment Management.

“But we also have to consider that the market price of future rate hikes is quite aggressive given the risks of recession,” she added.

Italy’s 10-year government bond yield rose 4 basis points to 3.67%, with the spread between Italian and German 10-year yields narrowing to 201 basis points.

Janus Henderson’s Mulliner said he expected the spread to hold around current levels ahead of the ECB’s policy meeting in July as markets wanted to see how well the anti-fragmentation tool was credible before acting on prices.

The ECB will likely drain cash from the banking system to offset any bond purchases made to cap borrowing costs for indebted eurozone states, sources told Reuters.

“Periphery spreads could come under pressure from latest ECB sources, throwing cold water on the idea that the ECB could sell Bunds to sterilize periphery buying under new anti-fragmentation tool “said Commerzbank analysts.

(Reporting by Stefano Rebaudo Editing by Mark Potter)

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James R. Rhodes