Euro zone bond yields fall as inflation shock subsides

Euro zone bond yields fell in early trade on Wednesday with the market taking a nuanced view on inflation ahead of euro zone consumer prices data due later in the session.

A surprisingly high inflation print from Germany pushed yields sharply higher on Tuesday as the country's Ifo Institute for Economic Research called on the European Central Bank to end its bond buying if the data was replicated across the euro zone.

A Reuters poll predicted a 1 per cent year-on-year rise in December compared to 0.6 per cent the previous month. German prices, harmonised to compare with other European countries, rose 1.7 per cent compared to expectations of 1.3 per cent.

"Euro zone inflation will probably be biased towards a higher rate, but it won't be bursting the market," said DZ Bank analyst Rene Albrecht. "In any case, much of the increase in headline inflation is related to oil prices. We don't expect the core inflation rate to pick up as much."

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Oil prices

Oil prices have risen steadily over the past year. Brent crude was at $56.11 per barrel, compared with $37.18 a year ago.

ING strategists suggested the high German inflation print was merely the trigger for a much-needed correction given that German government bond yields dropped as much as 17 basis points in the second half of December.

“Important will be the core [euro zone] figure and whether it will also nudge higher from the 0.8 per cent level where it has been for four straight months,” the strategists said in a note.

Most euro zone bond yields fell 1-3 basis points in early trades. Germany’s 10-year bond, the region’s benchmark, saw its yield drop 2 bps to 0.26 per cent.

A key measure of long-term euro zone inflation expectations, the five-year five-year forward rate, rose further on Wednesday to 1.77 per cent, its highest level in more than a year.

The ECB targets core inflation of just below 2 per cent for the single currency bloc.

Euro zone government bond yields are also expected to be affected by upcoming bond issuance, as January is traditionally a busy month for government borrowers.

On Tuesday the yield on Ireland’s 10-year bond rose 11 bps to 0.89 per cent ahead of a planned sale of 20-year bonds via syndication on Wednesday.

Rumours of a new syndicated sale of bonds by Portugal pushed that country's 10-year bond yield up 20 bps on Tuesday. The yield shed 5 bps of that gain to 3.89 per cent.

Reuters