Germany's 2-year yield , most sensitive to expectations about policy rates, was up 4 bps at 2.62%, effectively flat on the week. The case for lower European yields comes partly from the United States, where stalled talks over raising the government's debt ceiling and renewed fears of a regional banking crisis boosted concerns that the U.S. will enter a recession. U.S. data showed on Thursday the number of Americans filing new claims for jobless benefits jumped last week to the highest level since late 2021, while U.S. producer prices rebounded modestly in April.
"My view is that ECB governing council members are more worried about an economic slowdown in the U.S. and the possible spillover effects on the euro area," said Andrzej Szczepaniak, senior European economist at Nomura, who forecasts two more 25 bps rate hikes in June and July. U.S. yields are heading for a weekly decline. However, an ECB survey on Thursday showed that consumers had raised their inflation expectations in March for the first time since October last year, even as the rate of price growth fell.
Analysts at DZ bank said the survey suggested the rally in bond prices earlier in the week lacked "any fundamental justification". Bond yields fall when prices rise.
Money market bets on future rate hikes rose slightly during the week. The September 2023 ECB euro short-term rate forward was at 3.61%, implying expectations for an ECB deposit facility rate of 3.7% by autumn.
EYES ON ITALY
Italy's 10-year government bond yield rose 6 bps to 4.17% and was set to end the week down 2 bps.
The spread between Italian and German 10-year yields - a gauge of investor sentiment towards the euro zone's more indebted countries – was at 189.7 bps, showing a weekly tightening of 1.5 bps, ahead of Fitch's decision.
Some analysts expect the rating agency to confirm its assessment - BBB with a stable outlook - while flagging risks related to growth weakness in the medium-term and high public indebtedness at a time of increasing interest rates.
But according to Citi, "Italy is at risk of another negative outlook from Fitch," which could mean 10 bps of knee-jerk widening of the Italian-German yield spread. Citi analysts argued that such a move would increase the sensitivity of peripheral bonds - those of Italy, Spain, Portugal and Greece - to downside triggers, which may come from an acceleration in quantitative tightening from the ECB, or weakening economic growth. Others see this as less of a risk.
"While the stable outlook of the BBB-rating appears to be at
risk, not least after Fitch's negative rating action on France a
couple of weeks ago, it seems more likely that Fitch skips the
Italian review this week," said Christoph Rieger, head of rates
and credit research at Commerzbank.
"More relevant will be Moody's review next week, where any
negative rating action would lead to a junk rating," he added.
Fitch cut France's sovereign credit rating by one notch to
'AA-', saying fiscal metrics are weaker than its peers, and it
expects government debt/GDP to remain on a modest upward trend.
(Reporting by Stefano Rebaudo, additional reporting by Dhara
Ranasinghe and Alun John; editing by Sonali Paul, Sharon
Singleton and Alex Richardson)
