German yields fall but still at multi-year highs

German government bond yields fell on Wednesday but were still at multi-year highs on European Central Bank’s monetary tightening expectations.

Uncertainty about the next moves from the ECB increased volatility and left rates more exposed to spillover effects from foreign markets, mainly from U.S. rates.

The ECB last week avoided any pledge beyond the end of bond buying keeping its options open, while sources told Reuters it could still raise rates in July.

Germany’s 10-year government bond yield dropped 7 basis points (bps) to 0.853%, after hitting its highest since July 2015 at 0.961% on Tuesday.

U.S. Treasury borrowing costs fell in London trade, with the 10-year yield down 7 bps to 2.86%.

“The market continues to price in a euro zone terminal rate at 1.5% in line with money market bets on future rate hikes, while acknowledging that there will be no asset purchases very soon,” said Rohan Khanna, a strategist at UBS.

Some analysts expect the ECB to stop its bond-buying program as early as July.

However, “if Friday’s PMI data show a sharp slowdown in economic activity, Bund yields will probably fall as the ECB might delay its monetary tightening,” he argued.

Investors’ focus is also on inflation after a key gauge of long-term expectations rose above 2.41% on Tuesday, its highest level since 2012.

German producer prices rose 30.9% in March, reflecting the effects of the war in Ukraine for the first time.

“EUR rates are effectively catching up to the move seen in the U.S., with European markets assuming that the ECB will be forced into as aggressive and hawkish a U-turn as the Fed,” ING analysts said in a research note.

The ECB may raise interest rates as soon as July, Governing Council member Martins Kazaks said in an interview.

“Looking under the hood, it appears EUR rates have a lower conviction that their domestic central bank will step in aggressively to stop inflation,” ING analysts added, mentioning the euro zone’s real rates and yield curves.

Germany’s 10-year inflation-linked bond yield fell 5 bps to -1.848% after hitting its highest since March 2022 at -1.766% on Tuesday. It has been trading in a -1.8% and -2% range since mid-March, while the 10-year nominal yield rose by around 60 bps.

Break-even inflation rates – the difference between nominal and inflation-linked yields – were around 2.7%, a new high since 2010.

The shape of the yield curve shows markets do not anticipate any excessive tightening by the central bank, as it steepened after the ECB policy meeting last Thursday.

The spread between German 2-year and 10-year yields was at 83 bps on Wednesday, its widest level since December 2018 , from around 67 bps before the ECB meeting.

The spread between French and German yields was stable around 46 bps, while three polls put Macron at the highest level since before the first round, with an average score of 55.83%.

Italy’s 10-year bond yield fell 8 bps to 2.476%, with the spread with the 10-year German yield tightening to 160 bps.

(Reporting by Stefano Rebaudo; Editing by Emelia Sithole-Matarise)