Eurozone government bond yields fall after BoE recession warning
Yields on German government bonds fell on Thursday after the Bank of England (BoE) hiked rates but warned of recession risks as investors weighed whether the eurozone market is pricing the economy correctly. future rate hike path of the European Central Bank (ECB). The BoE’s 50 basis point (bp) hike was expected by most economists in a Reuters poll as central banks around the world scramble to contain soaring prices.
“I think the ECB and the BoE are in the same place as the Fed,” said Ben Lord, fund manager at M&G Investments. The yield on the UK 10-year gilt fell 9 basis points to 1.821%.
The yield on Germany’s 10-year government bonds, the bloc’s benchmark, fell 7 basis points to 0.8%. It was down 1bp just before the BoE announcement. It fell from over 1.8% in mid-June to its lowest level in nearly four months at 0.68% on Monday as investors lowered their expectations for ECB rate hikes.
Belligerent comments from U.S. Federal Reserve officials drew investors’ attention to further monetary tightening on Wednesday, pushing eurozone yields higher. According to Rohan Khanna, research strategist at UBS, a contagion effect of gilts on euro zone bonds was expected because “the Bank of England, like other major central banks, is facing stubborn inflation” in a context of recession risks.
Italian government bonds outperformed their peers, with the 10-year yield falling 9 basis points to 2.932%. The closely watched spread between Italian and German 10-year rates narrowed to 212 basis points. “As the bar for flexible PEPP reinvestments in BTPs looks rather low, we expect further tightening potential over the coming sessions,” Commerzbank analysts said in a research note.
The so-called first line of defense against fragmentation – reinvestments from the Pandemic Emergency Purchase Program (PEPP) – showed significant support for peripheral bond markets in Italy and Spain in July. said analysts, citing ECB data. The central bank has pledged to fight fragmentation or excessive widening of spreads that could hamper the transmission of monetary policy across the currency bloc.
In July, the Italian government of Mario Draghi collapses. Snap elections are due for September 25 and polls show a conservative alliance is on course for victory, with the far-right Brothers of Italy set to be the largest single party. “We believe the PEPP reinvestment is the tool the ECB will use if the Italian-German spread were to widen to around 250 basis points,” UBS’s Khanna said.
“At 300 basis points or more, they could activate the TPI, but not if political instability is causing the spread to widen.” The ECB announced a few weeks ago its Transmission Protection Instrument (TPI), a bond-buying program aimed at helping the most indebted countries and preventing financial fragmentation.
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