Euro zone bond yields rise on strong U.S. inflation data

Euro zone bond yields rose on Thursday after hotter-than-expected U.S. inflation data left investors wondering if the Federal Reserve will cut rates in June, as markets expect, or later. U.S. producer price index rose 0.6% in February, exceeding forecasts of 0.3% and the previous month's increase.

Euro zone bond yields rose on Thursday after hotter-than-expected U.S. inflation data left investors wondering if the Federal Reserve will cut rates in June, as markets expect, or later.

U.S. producer price index rose 0.6% in February, exceeding forecasts of 0.3% and the previous month's increase. This follows Tuesday's surprisingly sticky consumer prices for February. Germany's 10-year yield, the benchmark for the euro zone, was last up 6.5 basis points (bps) at 2.42%. Bond prices move inversely with yields.

Italy's 10-year yield rose 8 bps to 3.66%, after earlier in the day falling to its lowest level since late December. Yields on both side of the Atlantic have been on the rise this week as traders speculated whether persistent inflation may convince the Fed to hold off on cutting rates until after June, the timeframe currently priced in by markets.

"U.S. producer price data surprised on the upside, which is adding to fears that inflation pressures are building, and central banks may not be able to cut interest rates as fast as predicted," said Kathleen Brooks, research director at XTB. In the meantime, European Central Bank policymakers continued to line up behind a June interest rate cut but on Thursday offered

contrasting views on the timing and pace of further moves, suggesting there is no consensus yet within the Governing Council.

The yield spread between Italian and German 10-year government bonds, a gauge of the risk premium investors ask to hold bonds of the euro area's most indebted countries - was last at 124 basis points. Earlier in day, it hit 115.40 bps, its lowest level since mid January. Investors are closely watching the spreads' tightening across bond markets as they put aside concerns about Italy's budget deficit and reckon that a resilient economy will control the critical debt-to-GDP ratio.

Italy's budget deficit was far higher than targeted last year, but its public debt still fell thanks to strong inflation and higher-than-expected economic growth, data showed on Friday. "As even the budget deficit figures interrupted the spread tightening only for one day, a global risk reversal would probably be needed to turn things around," said Hauke Siemssen, rate strategist at Commerzbank.

"Yesterday's ECB announcements did nothing to counter the solid BTP spread tightening trend, which remains driven by the hunt for carry," Siemssen said, referring to the European Central Bank's operational framework review. The ECB wants to wean banks off free cash but will try to do so gently enough not to upset the financial system or lending, as the result of its long-awaited review showed.

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