Euro zone government bond yields edged up on Monday as investors balanced renewed inflation fears, after surprise oil production cuts, against expectations for tightening lending standards.
On Sunday, Saudi Arabia and other OPEC+ oil producers announced further output cuts of around 1.16 million barrels per day, which analysts said would cause an immediate rise in prices and the United States called inadvisable.
Analysts said that declines in bank stocks have historically tightened bank lending conditions, weighed on growth and slightly lowered core inflation. They also expect such a backdrop to lead the European Central Bank (ECB) towards a less aggressive rate hiking path.
The euro area's bank share index was up 1.55% at 103.7 on Monday, around 13% below its highest level since May 2018 hit in early March.
Germany's 10-year government bond yield, the bloc's benchmark, rose 1 basis point (bps) to 2.32%. It hit its highest since July 2011, at 2.77%, in early March.
Last week data showed euro zone core inflation accelerated in March, strengthening the case for more ECB rate hikes.
"In our view, core inflation will come in materially above the ECB's baseline scenario, and hence we believe this further strengthens the need for the ECB to continue hiking beyond current market pricing," said George Buckley, chief UK and euro area economist, referring to market expectations for a terminal interest rate of just over 3.50%.
Two-year German Schatz yields, the most sensitive to shifts in expectations for policy rates, rose 3 bps to 2.73%.
U.S. data released on Friday showed consumer spending rose moderately in February, remaining high enough to possibly allow the Federal Reserve to raise rates one more time this year.
The November 2023 ECB euro short-term rate (ESTR) forward was at 3.5%, implying market expectations for the ECB deposit facility rate to peak at around 3.6%.
ECB ESTR forwards priced the depo rate to peak at 4.1% before fears of a banking crisis hit financial markets.
Investors are also looking ahead to the euro area producer price index (PPI) and the ECB's Consumer Expectation Survey, both due on Tuesday.
Industrial production inflation remains an essential component of price pressure, while turbulence hitting the financial markets might have changed consumers' views.
"Tomorrow's ECB consumer expectation survey could provide further food for the doves for now," said Commerzbank's rate strategist Rainer Guntermann.
"Last month, 3y inflation expectations corrected sharply lower and reversed most of the jump seen last year."
Italy's 10-year government bond yield rose 5 bps to 4.15%, with the closely-watched spread between German and Italian 10-year yields - a gauge of investor confidence in the more highly indebted countries of the euro zone - widening to 180 bps.
Supply was in focus as the ECB started running the bonds off its balance sheet after ending its purchase programmes which supported the economy during the pandemic crisis.
"We check in on supply progress as Q2 begins," Citi analysts said in a research note. "European government bonds' resilience to persistent supply pressure looks set to continue, keeping spreads range-bound." (Reporting by Stefano Rebaudo, editing by Ed Osmond)
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