Euro zone bond yields fall after decline in German state's inflation

The ECB announced plans in mid-June to tackle fragmentation in euro zone bond markets, or an excessive widening of spreads between core and peripheral yields that might hamper monetary policy transmission across the bloc. "The central bank seems to be taking the right direction regarding the anti-fragmentation tool as they pulled off from the idea of selling Bund to sterilise bond purchases on peripheral bonds, which might have been easily challenged in Court," said UBS strategist Khanna.

Euro zone government bond yields fell on Wednesday as a surprise decline in inflation in the German state of North-Rhine Westphalia shifted investors' focus to a possible less aggressive path of monetary tightening. Bavaria, Hesse, Brandenburg and Baden Wuerttemberg showed a zero to +0.2% monthly change in consumer prices, while NRW numbers fell by 0.1%.

Data from Spain showed that 12-month inflation rose to 10.2% in June, the first time it surpassed 10% since April 1985, from 8.7% the previous month. Rohan Khanna, a research strategist at UBS, said NRW data "might be a turning point that could moderate the approach of the European Central Bank".

However, it is probably "too early to extrapolate ahead of Friday's euro zone numbers", he added. Germany's 10-year government bond yield, the benchmark for the euro zone bloc, fell 2.5 basis points (bps) to 1.6% after dropping as much as 9.5 bps early in the session.

"The ECB is under pressure to deliver (rate hikes), and inflation will keep pressure on them," said Chris Attfield, European rates strategist at HSBC. "The euro area economy is running less hot than in the U.S, and the window to hike is closing: but the narrative will probably change by the end of the year if inflation subsides and economic growth slows down," he added.

German bond yields jumped by about 20 bps earlier this week on inflation fears, with ECB president Christine Lagarde not sounding cautious about growth risks and pledging to act in a "determined and sustained manner" to fight inflation. Analysts said the ECB was caught between a rock and a hard place as balances the need to tame inflation against the risk of triggering a recession.

Central banks speakers at the ECB Forum in Sintra, Portugal, remained under the spotlight as analysts watched for any hint about the ECB potentially moderating its hawkish tone. Italy's 10-year government bond yield fell 6.5 bps to 3.6%, with the spread between Italian and German 10-year yields tightening to 198 bps.

Analysts expect the spread to remain around 200 bps before the ECB's July policy meeting as markets want to see how credible its so-called anti-fragmentation tool is before taking any price action. The ECB announced plans in mid-June to tackle fragmentation in euro zone bond markets, or an excessive widening of spreads between core and peripheral yields that might hamper monetary policy transmission across the bloc.

"The central bank seems to be taking the right direction regarding the anti-fragmentation tool as they pulled off from the idea of selling Bund to sterilise bond purchases on peripheral bonds, which might have been easily challenged in Court," said UBS strategist Khanna. Some German politicians had filed complaints with the constitutional court against the ECB bond-buying scheme.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)