German bond yields hit four-month highs, bets wane on ECB cuts
ADVERTISEMENT The ECB left interest rates at 2% on Thursday, as expected, and President Christine Lagarde suggested policymakers were less concerned than before about an abrupt slowdown in growth and inflation over the coming year. Bond yields rose sharply in response.
Meanwhile, optimism is growing that the European Union will be able to secure an agreement with the United States on trade at a lower tariff than the 30% threatened by President Donald Trump if there is no deal by his August 1 deadline.
Government bonds came under pressure, as did gold and safe-haven currencies like the Japanese yen and Swiss franc. Two-year German Schatz yields, which rose by nearly 12 basis points on Thursday in their biggest one-day increase since mid-May, were up 3.6 bps at 1.947%, their highest since April 3, the day after Trump's "Liberation Day" announcement on tariffs.
Benchmark 10-year German yields were up 6 bps to 2.75%, their highest since the end of March, while Italian yields rose 7 bps to 3.636%, leaving the gap between the two at 88.2 bps, its widest in a week.
ADVERTISEMENT Two sources told Reuters on Thursday that ECB policymakers were setting the bar high for a September rate cut and would need to see a significant deterioration in growth and inflation before backing further easing.
BRIGHTER OUTLOOK
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Recent economic data suggests the euro zone is weathering uncertainty over U.S. tariffs reasonably well. Euro zone business activity hit an 11-month high in early July, based on HCOB's preliminary composite euro zone Purchasing Managers' Index, compiled by S&P Global on Thursday.
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"After good PMI numbers and a positive tone from the ECB, the path towards higher rates is becoming even clearer. If a trade deal gets signed, we should see rates move up further, with the 10-year swap rate hitting at least 2.8%," ING rates strategist Michiel Tukker said. The 10-year swap rate, an indicator of long-term borrowing costs, is hovering around 2.7%, its highest since March, having risen by nearly 20 bps in the last month.
ADVERTISEMENT Tukker said a move towards 3% would likely be slower and would depend on growth remaining resilient.
Money markets show traders are undecided about another ECB rate cut this year, attaching about a 30% chance of a drop below 2% by the end of December. Reflecting some of that greater confidence in the outlook was a modest improvement in German business morale in July. A survey on Friday from the Ifo institute showed its business climate index rose to 88.6 this month - the highest in 13 months - from 88.4 in June, slightly below a Reuters forecast for 89.0.
A separate report from the ECB showed bank lending in the euro zone grew at the fastest pace in two years last month, extending a gradual recovery fuelled by lower borrowing costs and a stabilisation in the economy.
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