Euro zone government bond yields rise, focus on ECB

© Reuters. FILE PHOTO: The euro sign is photographed in front of the former headquarters of the European Central Bank in Frankfurt, Germany, April 9, 2019. Picture is taken on slow shutter speed while the camera was moved. REUTERS/Kai Pfaffenbach

By Stefano Rebaudo

(Reuters) – Euro zone bond yields rose on Friday, tracking moves in U.S. Treasuries after falling sharply the previous day as the Russian invasion of Ukraine boosted demand for safe-haven assets.

Investors are now looking to see what impact the war will have on the European Central Bank’s future policy decisions, analysts said. The ECB discussed the possible consequences of war in Ukraine when it met for a previously-scheduled meeting in Paris on Thursday.

Bond yields are now just off the levels they were before Russia attacked Ukraine.

Germany’s 10-year government bond yield, the benchmark of the bloc, jumped more than 5 basis points to 0.22%. It closed at 0.226% on Wednesday before the news of the Russian attack.

The spreads between Germany’s long and short maturity yields tightened slightly.

The U.S. 10-year Treasury yield briefly rose more than 3 bps to 2.007% before retreating partially to trade at 1.98%

“It seems likely that the ECB will revise its inflation forecast upwards. So we may still get an accelerated tapering, as long as the conflict stays within Ukraine,” Andrew Mulliner, head of Global Aggregate Strategies at Janus Henderson, said.

ECB chief economist Philip Lane told policymakers meeting in Paris the Ukraine conflict may reduce the euro zone’s economic output by 0.3%-0.4% this year.

“It’s too early to have strong opinions on the direction of rates and spreads,” Erjon Satko, fixed income analyst at BofA said.

“Much of it will depend on the consensus about the ECB’s monetary policy reaction, which is not clear yet,” he added.

Money markets are pricing in an around 80% chance of a 10 bps rate hike in July and a 95% chance of rate hikes worth 40 bps by year-end. [IRPR]

“While the Russia-Ukraine crisis generates considerable risks in its own right, it also adds an unwelcome geopolitical layer to the challenge of high inflation,” Erik Knutzen, CIO multi-asset, Neuberger Berman, said.

Russia is one of the world’s biggest energy producers, and both it and Ukraine are among the top exporters of grain. War and sanctions will disrupt economies around the world. Oil and grain prices have soared.

“The risk of central bank policy error – raising rates too aggressively or falling ‘behind the curve’ – are elevated,” Neuberger Berman’s Knutzen added.

Italian government bonds outperformed their peers, with the 10-year yield rising 1.5 bps to 1.832%.

The closely watched spread between German and Italian 10-year yields tightened to 159 bps.

In a sign that bond market liquidity came under pressure this week, trading in euro zone government bonds slowed sharply on Thursday following Russia’s invasion.