German two-year yields hit 2011 high, ECB rate hike not fully passed on to repo

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Short-term German bond yields hit 11-year highs on Friday as ECB policymakers stressed tackling rising prices was their priority and August inflation in the bloc was revised to the rise.

There was also growing concern that the European Central Bank’s unprecedented rate hike last week has not fully filtered through to money markets.

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ECB President Christine Lagarde and Vice President Luis de Guindos made comments prioritizing the bank’s fight against inflation, even as the bloc braces for recession.

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The European Central Bank raised its benchmark rate by a record 75 basis points last week to “predict” policy tightening and promised further hikes, prompting investors to up their bets on the size of the rate hike. the bank.

On Friday, traders continued to raise those bets and forecast 70 basis points of increases in October and December, and peak rates at around 2.6% in mid-2023.

Data showing that eurozone inflation rose 0.6% in August from July, versus an estimate of 0.5%, also put upward pressure on bond yields.

Germany’s two-year yield, sensitive to rate expectations, rose 9 basis points to 1.62%, the highest since 2011.

The 10-year rate, the benchmark for the euro zone, rose 8 basis points to 1.817%, the highest since mid-June.

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The yield spread between German 10-year and 30-year bonds, which reversed for the first time on Thursday, was around -2 basis points.

“(The market) is pricing in how badly the ECB is going to have to do to lower inflation expectations,” said Lyn Graham-Taylor, senior rates strategist at Rabobank.


Emphasis was also placed on the money markets. As the bloc’s overnight rate, the ESTR, rose in line with the ECB’s 75 basis point hike, rates on German buyback deals, where investors borrow bonds in exchange for cash, rose only about 55 basis points, according to Commerzbank data.

That means the ECB’s rate hike is not fully passed on to a key market, potentially weakening some of its efforts to tighten policy, analysts said.

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Last week, the ECB moved to temporarily pay interest on member states’ cash deposits, responding to fears that failure to do so would worsen a collateral shortage in the bond market.

This shortage is the result of years of ECB purchases which have also made it very expensive to borrow bonds in the repo market.

“We would have expected such an altered transmission in repo markets only in the absence of ECB intervention last week,” said Michael Leister, head of interest rate strategy at Commerzbank.

The spread between two-year interest rate swaps and German bond yields first narrowed after the ECB’s filing decision, after hitting its highest level since the eurozone debt crisis . But it reversed much of that fall this week in another sign the market remains under pressure.

Leister expects pressure to remain on repo markets and swap spreads as the ECB’s measure on deposits is only temporary, adding that it increases the risk of further intervention. (Reporting by Yoruk Bahceli; Editing by Ana Nicolaci da Costa, Andrew Heavens and Toby Chopra)



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James R. Rhodes