Euro zone bond yields rise as inflation expectations increase

Euro zone bond yields rise as inflation expectations increase

Euro zone government bond yields climbed to a two-week high on Wednesday, following an European Central Bank (ECB) survey that revealed a slight increase in consumer expectations for inflation, bolstering the case for another interest rate hike. The ECB's Consumer Expectations Survey indicated inflation expectations three years ahead had risen to 2.4% in July from 2.3% in June, exceeding the ECB's 2% target.

This development has led markets to price in an approximately 33% chance of a 25 basis points (bps) rate hike at the ECB's upcoming meeting on September 14. Klaas Knot, a member of the ECB governing council, suggested on Wednesday that investors betting against an interest rate increase next week may be underestimating its likelihood. "Higher inflation expectations from the ECB survey and extension of oil production cuts from Saudi and Russia added to the bearish pressure," Mohit Kumar, an interest rate strategist at Jefferies, told Bloomberg.

On Tuesday, oil prices surged more than 1%, contributing to inflation concerns due to supply cuts from Saudi Arabia and Russia. Germany's 10-year government bond yield, which serves as the benchmark for the euro zone, rose to its highest level since August 23 and was last up by 2.5 bps at 2.63%. Italy's equivalent yield also reached a two-week high but remained flat at 4.34%.

The spread between Italian and German 10-year yields, a measure of investor sentiment towards the euro zone's more indebted countries, reached its widest level in more than two weeks at 170 bps. Despite these developments, investors have been reluctant to increase their bets on an ECB rate hike given the deteriorating economic conditions in the euro zone. Data showed that industrial orders in Germany fell more than expected in July.

Germany's IfW economic institute has revised its economic outlook for the year, predicting that the economy will contract by 0.5% instead of the previously estimated 0.3%.

Meanwhile, market participants see less than a 50% chance of an interest rate hike from the ECB next week, which has contributed to recent weakness in the Euro. The Eurozone's single currency is expected to suffer further losses in the coming week according to new studies.

The European Central Bank is unlikely to support the Euro when it meets on September 14 according to one analyst who assessed the foreign exchange landscape following the release of stubborn Eurozone inflation data earlier this month.

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