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

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

The ECB is all but certain to keep policy unchanged when it meets on Thursday and push back against growing expectations for an interest rate hike next year, even though it may admit that inflation will be higher than projected.

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 throughout the bloc.

“The ECB will have to address the fact that its inflation forecasts are too low without giving a sense of panic,” said ING rates strategist Antoine Bouvet. “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 in early European trade ahead of the 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 on the day.

Italy, which is seen as most dependant on ECB largesse, saw its borrowing costs rise 4-6 bps across the government bond curve.

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.

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.
Source: Reuters (Reporting by Abhinav Ramnarayan; Editing by Emelia Sithole-Matarise)