Investors have been balancing expectations for a quick end to the Federal Reserve's monetary tightening cycle against remarks from ECB hawks calling for more rate hikes. Germany's 10-year government bond yield , the bloc's benchmark, fell 10 basis points to 2.08%. It fell to its lowest since mid-December 2022 at 1.923% last week on fears of a banking crisis in Europe, after posting its highest since July 2011 at 2.77% in early March. German 2-year yield , most sensitive to expectations for policy rates, dropped 14 bps to 2.34%. Having raised interest rates at the fastest pace on record to tame inflation, the world's top central banks are openly contemplating an early end to their rate hikes, not least because of financial turmoil in recent weeks. However, Dutch central bank chief Klaas Knot said on Thursday the ECB may need to raise rates again in May, adding a powerful voice to a chorus of policymakers calling for tighter policy even after recent market turmoil.
Market bets on ECB's future rate hikes stopped rising on Thursday after the Federal Reserve indicated it was on the verge of pausing further increases in borrowing costs.
The September 2023 ECB euro short-term rate forward was at 3.25% -- implying expectations for a depo rate at 3.35% -- after hitting 3.425% on Wednesday. Investors' focus was also on flash reading for the March purchasing managers' index (PMI) after French business activity strengthened in March by more than forecast. German business activity expanded for a second month running in March, boosted by a services sector revival. Next week's focus will turn to the euro's preliminary inflation reading for March, as solid data may embolden ECB hawks, boosting market expectations for future rate hikes. Citi expects the breakdown details of next week's numbers to be hawkish, with core inflation still up (5.7%). "It is too early to draw conclusions on the impact of the recent banking turmoil on the inflation outlook, as this will depend on the still-uncertain implications for final demand and the ECB's reaction," said Citi economist Giada Giani. ING expects the relevant core inflation to edge higher to a new record. Italy’s 10-year bond yield fell 7 bps to 3.98%, with the closely watched spread between Italian and German 10-year yields was at 189 bps. (Reporting by Stefano Rebaudo, editing by Christina Fincher)
