By Geoffrey Smith
Investing.com -- Eurozone bonds tumbled on Friday after another set of stronger-than-expected inflation data in the U.S. reinforced fears that central banks on both sides of the Atlantic will continue to tighten their monetary policy.
Benchmark government 2-Year note yields rose by between 8 and 13 basis points in response to the U.S. price index for personal consumer expenditures coming out much stronger in January than expected. That came on the heels of stronger-than-expected reports last week for consumer and producer price inflation in January. Taken together, the data make it more likely that the Federal Reserve will keep raising the fed funds target range well into this year, rather than pausing by spring, as many had hoped.
That, in turn, raises the likelihood of more interest rate hikes by the European Central Bank, not least since core inflation in the Eurozone is still on the rise, ticking up to 5.3% in January from 5.2% in December, according to delayed figures from Eurostat this week.
Influential ECB board member Isabel Schnabel had said last week that a 50-basis-point hike in the ECB's key interest rates next month is all but inevitable, given that there is there is no sign yet of a broad disinflation process starting yet in the Eurozone (in contrast to Federal Reserve chair Jerome Powell's assessment of the U.S. situation after the Fed's policy meeting in December).
Euro interest rate markets are now pricing in expectations that the ECB's rates will rise to their highest in the 24-year history of the euro later this year. Until Friday, forward rates had implied that the chilling effect of those rate hikes would prompt the ECB to reverse course and cut rates before the end of this year. However, after the U.S. data on Friday, market participants pushed back their expectations of a first ECB cut into 2024. Futures on the benchmark Euro Short Term Rate imply overnight rates of 3.75% at the end of this year.
Higher bond yields mean that the cost of servicing Eurozone government debt is likely to rise throughout the next couple of years. However, in contrast to the euro crisis 12 years ago, there are few signs of markets betting on the Eurozone breaking up as a result, thanks largely to the €800 billion recovery and resilience fund stitched together by the EU during the pandemic, which is now being rolled out to member states.