Bund selloff continues as markets price in higher growth, fewer rate cuts

They jumped more than 30 bps on Wednesday, recording the biggest daily rise since May 1997. Markets are confident the European Central Bank will cut its key interest rate by 25 basis points to 2.5% at its meeting later on Thursday, but have scaled back bets on future cuts as they expect higher government spending to boost growth and inflation.

Benchmark Bund yields rose on Thursday after recording their biggest daily rise in more than 25 years the day before, as Berlin's plans for a huge spending package led investors to expect a sharp increase in German bond supply.

Germany is in for a massive ramp-up in spending, with a 500 billion euro special fund sought for infrastructure and plans to unshackle defence investment from restrictive borrowing rules. "Given inevitable lags in fiscal policy, additional spending could only start to filter through to the economy later this year and into 2026," said Mark Haefele, chief investment officer at UBS Global Wealth Management.

"But despite these caveats, the bold fiscal plan has the potential to boost growth and support euro zone assets," he added, mentioning a possible lift to confidence and an improving backdrop for equities. Yields on 10-year Bunds were up 7 basis points at 2.86%, after hitting 2.929%, their highest since October 2023. They jumped more than 30 bps on Wednesday, recording the biggest daily rise since May 1997.

Markets are confident the European Central Bank will cut its key interest rate by 25 basis points to 2.5% at its meeting later on Thursday, but have scaled back bets on future cuts as they expect higher government spending to boost growth and inflation. Markets are pricing in around 50% chance of another cut in April and a depo rate of 2.05% in December , from 1.92% late on Tuesday.

A key market gauge of long-term euro zone inflation hit 2.2856%, its highest since July 2024. "We are less sure it (change in German fiscal regime) will prevent the ECB from cutting to 2%, and below, this year," said Jamie Searle, European rates strategist at Citi.

He cited several factors supporting this view, including U.S. tariffs on Europe likely coming on April 2, negative growth developments, the disinflationary effect of falling oil prices, and the expected delay in fiscal spending implementation. Germany's 2-year yield, more sensitive to ECB policy rates, dropped one basis point, after rising to 2.319%, its highest since mid-January earlier on. It rose 22.5 bps on Wednesday, in its biggest daily jump since March 2023.

Other euro area bond yields followed Bunds, leaving spreads roughly unchanged. Analysts argued that joint European Union borrowing for new investments would be crucial to support government bond prices of highly indebted countries such as Italy and France.

The yield spread between French and German bonds was steady at 70 basis points, at the lower end of its recent range. The yield gap between Italian and German bonds - a market gauge of the risk premium investors ask to hold Italian debt – widened 2.5 bps to 106 bps, after dropping below 100 bps for the first time since 2021 the day before.

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