UPDATE 2-Euro bond yields rise; inflation expectations at May 2019 high

Yoruk Bahceli and Elizabeth Howcroft
·3 min read

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Rewrites throughout, adds details)

By Yoruk Bahceli and Elizabeth Howcroft

LONDON, March 3 (Reuters) - Euro zone government bond yields rose again on Wednesday amid doubts about whether the bloc's central bank will step in to curb the recent sharp increase, while data reflected optimism over a post-pandemic economic recovery.

Bets that U.S. stimulus would boost inflation and growth pushed government bonds across the globe to their worst performance in years in February.

Although yields have dipped from their highs this week, pressure remains, with Germany's 10-year Bund yield, the benchmark for the region, rising 5 basis points to -0.29% on Wednesday. However, it was still far below its Feb. 26 spike of -0.203%.

In a sign that the 'reflation' trade is not over yet, a key gauge of long-term euro zone inflation expectations rose to its highest since May 2019 above 1.39%.

Analysts had started questioning the reflation-trade last week, as inflation-adjusted 'real' and nominal yields had continued rising while inflation expectations were falling.

"The fact that, looking at the (five-year five-year) forward rate, inflation expectations in Europe are already back to pre-pandemic levels, to us, argues more than enough good news is priced in as it presupposes no permanent scarring from the virus itself," said Richard McGuire, head of rates strategy at Rabobank.

After dovish messaging earlier in the week, officials indicated the ECB's Governing Council is divided on whether or not bond buying should be accelerated, with Bundesbank President Jens Weidmann and ECB vice president Luis de Guindos playing down concerns.

The bank did not increase its net or gross bond purchases last week, although many in the market have called for more saying there is less justification for the rise in European borrowing costs than in the U.S. given a weaker economic outlook.

Bloomberg News, citing sources, said ECB policymakers see no need for drastic action to fight rising yields, instead believing verbal intervention and the flexibility of the bond buying programme is enough.

Meanwhile, IHS Markit's February Composite Purchasing Managers' Index showed that although the euro zone economy is almost certainly in a double dip-recession, hopes for a wider vaccine rollout have driven optimism to a three-year peak.

Italy's first green bond, which will finance environmentally-friendly projects, attracted orders for more than 80 billion euros ($96.53 billion), a lead manager said.

The country's 10-year Btp yield was last up around 7 bps at 0.76%, pushing the closely watched gap between Italian and German 10-year yields to 103 basis points, nearing last week's peak around 107 bps..

Elsewhere, Britain's government bond yields posted their biggest rise since just before December's Brexit deal after the budget revealed the country will need to borrow much more than expected this year, which also pressured bonds in other regions. ($1 = 0.8288 euros) (Reporting by Yoruk Bahceli and Elizabeth Howcroft, editing by Larry King, Kirsten Donovan)