UPDATE 2-Euro zone bond yields fall, German 2-year hits 2011 high

·2 min read


By Stefano Rebaudo

May 18 (Reuters) - Euro zone bond yields fell on Wednesday having jumped the previous day after hawkish comments from the European Central Bank increased market bets on rate hikes.

The German 2-year yield, more sensitive to interest rate hikes, was down 1.5 basis points (bps) at 0.365%, but after hitting its highest since November 2011 at 0.444% earlier in the session.

Germany's 10-year government bond yield, the bloc's benchmark, was down 4.5 bps at 1.009%.

Risk appetite faded after a few days of equity rebound as concerns about the economic growth outlook and rising inflation knocked sentiment.

ECB hawk Klaas Knot said a 50 bps rate hike in July was possible if inflation broadened.

"This is the first time an ECB official talks about a 50 bps hike," said Rohan Khanna, a research strategist at UBS.

Money markets are pricing in 106 bps of ECB rate hikes by year-end from 105 bps on Tuesday, in addition to an almost 70% chance of a 50 bps rate hike in July.

"The broad picture remains very uncertain, and the market has to price in all the tightening risks, also the less likely ones," Khanna added.

The introduction of the 6/24 Schatz - a short-dated German government bond - on Tuesday produced the second-lowest bid cover ratio of any Schatz auction.

"Markets are way overpriced on ECB rates but it makes sense - even if you think a 50 bps hike is unlikely if some council members are talking about it, there there's got to be a chance," Richard McGuire, head of rates strategy at Rabobank said.

China's "zero-tolerance" COVID strategy is also in focus after causing significant economic damage at home and supply chain bottlenecks which affected the global economy. It has been one of the main factors dampening risk appetite.

"To be fair, one shouldn't understate the importance of hopes that lockdowns in Shanghai may be nearing its end," ING analysts said.

"This has allowed global-growth sensitive Europe to look to a less gloomy future and helped 10Y Bund yields test the 1% level once again," they added.

Despite no new cases, authorities in Shanghai are not lifting the lockdown immediately, instead gradually easing restrictions until June 1, with some shops allowed to open this week and public transport expected to resume over the weekend partly.

Italy's 10-year government bond yield was down 3 bps at 2.93%, with the spread between Italian and German 10-year yields at 192 bps.

(Reporting by Stefano Rebaudo, additional reporting by Dhara Ranasinghe; Editing by Angus MacSwan)