Bond yields in Europe’s largest economies rose in August

German government bond yields rose by the most in decades in August, reflecting glowing inflation data and rising interest rates.

The yield on 2-year bunds issued by Europe’s largest economy has risen by 85 basis points this month. That is set to be the biggest monthly increase since 1981, according to Refinitiv data.

Meanwhile, the benchmark 10-year bond yield rose more than 65 basis points, the highest monthly increase since 1990.

The two-year interest rates on German bunds were 1[ads1].117% at 8 a.m. ET Wednesday, 2 basis points higher than the previous day. The 10-year yield was up 1 basis point to 1.522%.

French bond yields have also risen, with the 2-year yield rising to a level last seen in 2011, and the 10-year yield rising to a level last seen in 2013.

Flash figures published on Wednesday morning showed eurozone inflation hit a new record high of 9.1% in August, driven by soaring energy costs and higher prices for food, alcohol and tobacco.

Higher interest rates tend to make bonds less attractive and lower prices, which moves inversely to yields.

“European bonds largely follow developments in energy markets,” Antoine Bouvet, senior rates strategist at Dutch bank ING, told CNBC via email.

“With energy bills set to jump across Europe, bond markets are concluding that the European Central Bank will be forced into more aggressive hikes this cycle.”

This was reinforced by hawkish comments by Federal Reserve officials at the Jackson Hole symposium, he added.

Following the release of the inflation data, analysts at Pantheon Macroeconomics said they now expect the ECB to raise the deposit rate by 50 basis points three more times before the end of the year.

The bank raised interest rates by 50 basis points to zero last month.

Yield fall

However, ING’s economics team predicts that a 50 basis point increase from the ECB next week will be followed by a 25 basis point increase in October, followed by a longer break in the spring.

That’s because it may be “easier said than done” for the ECB to follow the Fed’s lead in viewing a recession as an acceptable cost of tackling inflation, said Carsten Brzeski, global head of macro research. “If we’re right, bond yields should also start to fall again,” Brzeski said.

The outlook for bonds largely depends on how energy trades in the coming weeks, as the market focuses on inflation trends, ING’s Bouvet added.

“There will come a time this winter when the growth implications will kick in and we expect bond yields to fall again,” he said.

“This will lead to more underperformance of riskier assets, increase demand for safe-haven government bonds, and also push markets to question their assumptions about central bank hikes.”

The team expects 10-year yields to trade through 1% in the first quarter of 2023, down from current levels of 1.5%.

Meanwhile, UK 10-year bond yields are set to record their biggest increase since May 1994 this month, Reuters reported. The 10-year gilt yield was up 8 basis points to 2.793% at 8 a.m. ET, up from 1.72% in early August.

In the US, the yield on the 2-year government bond has reached an almost 15-year high.

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