Euro zone government bonds held steady on Tuesday even as money markets slowly increased their bets on another rate hike by the European Central Bank, if not necessarily at its meeting this week.
Investors are almost evenly split on whether the ECB will raise interest rates on Thursday, with euro short-term rate (ESTR) forwards pricing roughly a 50% chance of a 25 basis point (bps) hike, from around 40% the day before.
Money markets are close to fully pricing in a 25 basis point ECB move by year-end, with no further tightening afterwards.
Expectations that rate hikes are near the end was a factor in helping German investor sentiment unexpectedly improve in September.
But bonds remained fairly steady despite the gradual ticking up in ECB rate expectations, cautious ahead of Wednesday’s crucial U.S. inflation data that will set the tone for whether the Federal Reserve will raise rates again, and the ECB’s Thursday meeting.
Germany’s 10-year government bond yield, the benchmark for the euro area, edged up to 2.64%.
“A hawkish tone from the U.S. CPI data and a hike from the ECB could give front-end rates a larger lift this week,” said Benjamin Schroeder, senior rate strategist at ING.
Germany’s two-year bond yield was 3.12% up 3 bps.
Recent comments from Fed officials have indicated the Federal Reserve is content to keep rates steady at its next policy meeting on Sept. 19-20 but is not ready to declare the war on inflation is over.
Also in the mix on Tuesday was data showing German wholesale prices fell for the fifth month in August due to lower prices for mineral oil products.
However, oil prices, which have been triggering concerns about the inflation outlook, rose with Brent up nearly 2%.
Italy’s 10-year government bond yield, the benchmark for the euro area periphery, edged up 1 bp to 4.4%.
The spread between Italian and German 10-year yields – a gauge of investor sentiment towards the euro zone’s more indebted countries – was at 174.5 bps, just off its widest level in two months.