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Euro zone bond markets point to 'stagflation' ahead of ECB presser

Euro zone bond markets point to "stagflation" ahead of ECB meet
Euro zone bond markets point to "stagflation" ahead of ECB meet Copyright Thomson Reuters 2021
Copyright Thomson Reuters 2021
By Reuters
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By Abhinav Ramnarayan

LONDON -Short-dated euro zone bond yields jumped and long-term inflation expectations hit a new seven-year high on Thursday, putting pressure on European Central Bank officials to address rising inflation when they talk to the press later in the day.

At the same time, the gap between Germany's 10-year and 30-year bond yields shrank to its narrowest since March 2020, pointing towards "stagflation" worries among bond investors.

The ECB kept policy unchanged, as widely expected, holding fire before a crucial December decision on whether to end emergency stimulus and return policy to a more normal setting.

But the press conference due to begin at 1230 GMT will be keenly watched to see if ECB chief Christine Lagarde addresses the issue of high inflation.

Policymakers around the world are under pressure to re-examine the unprecedented levels of stimulus they have been pumping into the economy in the face of high inflation and the impact that will have on disposable incomes.

"The ECB will have to address the fact that its inflation forecasts are too low without giving a sense of panic," ING rates strategist Antoine Bouvet told the Reuters Global Markets Forum. "You can see how it is in its interest to say as little as possible."

Short-dated government bond yields jumped between four and five basis points (bps) in early European trade ahead of the ECB meeting, with Germany's two-year Schatz yield hitting a 14-month high of -0.599%.

Other short-dated euro zone government bond yields were also 4-5 bps higher at the open, before falling back.,

Italy, which is seen as most dependant on ECB largesse, saw its borrowing costs rise 5-8 bps across the government bond curve, with 10-year yields matching a recent five-month high.,

A key gauge of long-term euro zone inflation expectations, the five-year, five-year forward swap rate, opened the session at a new seven-year high of 2.0987%; well above the ECB's 2% target, before falling back to 2.0962% by 1200 GMT.

The ECB statement did not move markets much, as the bank was widely expected to keep stimulus unchanged.

The big challenge for policymakers is the prospect of "stagflation" - rising inflation without a corresponding bounce in the underlying economy. Withdrawing monetary support in these circumstances could hurt the businesses that underpin the recovery from the COVID-19 pandemic.

These fears are being reflected in the bond market in the shape of flattening curves where shorter-dated bond yields are rising much quicker than longer-dated ones.

The gap between Germany's 10-year and 30-year bond yields, for example, is at its narrowest since March 2020 - the onset of the COVID-19 pandemic - at 29.1 bps.

"This highlights market concerns that growth risks are on the rise while central banks are seen forced into rate hikes," said Commerzbank's Rainer Guntermann.

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