German bond yields rise following ECB comments, spreads narrow

German government bond yields rose to within striking distance of their multi-year highs as renewed inflation concerns and European Central Bank’s hawkish comments kept markets on edge.

Spreads between core and peripheral bond yields tightened after ECB President Christine Lagarde reaffirmed on Monday a commitment to avoid fragmentation — a yield spread widening which might hamper the transmission of monetary policy across the euro area.

ECB chief economist Philip Lane said a record-high rise in consumer prices risked triggering “inflation psychology,” which involves behaviors perpetuating inflation.

There are good reasons to speed up the exit from exceptionally easy monetary policy, Finnish Governing Council member Olli Rehn said on Tuesday.

Germany’s 10-year government bond yield, the benchmark of the bloc, rose 3 basis points (bps) to 1.77%. It hit its highest since January 2014 at 1.926% on Thursday.

“Central banks have realized that inflation has not peaked yet, so they’re ready to be more aggressive. That’s why yields keep rising,” said Mohammed Kazmi, portfolio manager at Union Bancaire Privée.

“Current pricing may be enough as the market is betting on the ECB to take rates well above neutral. That said, central banks have become more data-dependent, which means that there will be more volatility around the inflation numbers,” he added.

Unicredit analysts expect the ECB rhetoric to remain hawkish and the 10-year Bund yield to reach 2% in the coming months.

Italy’s 10-year yield initially fell but was last unchanged on the day at 3.8%. The spread between Italian and German 10-year yields hit 195.5 bps, a two-week low, before widening to 202 bps in later European trading.

Other peripheral euro zone bond yields dropped or were little changed on Monday .

Deutsche Bank analysts recalled Lagarde had said on Monday the ECB needed “to be absolutely certain” that monetary policy was being transmitted equally across the euro area.

“So not quite ‘whatever it takes’ but along the same lines,” they argued in a note.

But Slovak central bank governor Peter Kazimir and his Finnish peer Rehn set a high bar for any ECB intervention on the bond market to avoid fragmentation.

Unicredit analysts flagged that the German break-even rate -– a gauge of inflation expectations measured as the difference between inflation-linked and nominal bond yields –- did not track the recent rise in nominal rates.

While German 10-year bond yields rose from around 1% at the end of May to 1.926% on June 16, 10-year break-evens hit their highest at 2.77% on April 29 and then fell to around 2.2%.

The European Union raised 5 billion euros from the sale of a new, 25-year green bond, seeing over 32 billion euros of demand, according to a lead manager.

As part of its third quarter issuance plans, Germany said it would increase its inflation-linked bond due April 2046 by 500 million euros in order to be able to meet any demand flexibly in addition to its regular auctions.

(Reporting by Stefano Rebaudo; Additional reporting by Tommy Reggiori Wilkes; Editing by Alison Williams)