Data last week from Europe and the U.S. showed consumers had raised their inflation expectations, particularly in the longer term, serving as a reminder to central banks that the fight against inflation still has further to go.
"The inflation expectations data from the U.S. on Friday was fairly high," said Jens Peter Sørensen, chief analyst at Danske Bank.
"Central banks will be worried about second round effects of inflation such as higher wage claims, but if you get inflation down quickly, people will not demand such high wage increases," Sørensen added.
Germany's 10-year government bond yield rose 4 basis points (bp) to 2.307%.
The policy-sensitive two-year yield increased by 4 bps to 2.657%.
European Central Bank policymaker Peter Kazimir said on Sunday the central bank may need to raise interest rates for longer than previously thought to help tame inflationary pressures.
The ECB has raised its deposit rate by a combined 375 bps since the middle of last year but the May hike of 25 bps was the smallest in the tightening cycle so far.
Money market bets on future tightening have held firm after rising slightly during the latest week. The September 2023 ECB euro short-term rate forward was at 3.61%, implying expectations for a peak ECB deposit facility rate of around 3.7%. Italian bonds were slightly outperforming their German counterparts after Fitch on Friday affirmed Italy's sovereign credit rating at 'BBB' with a stable outlook, when there had been an outside chance the sovereign rating could have faced a downgrade.
"The rating is supported by a diversified, high value-added economy," ratings agency Fitch said.
Danske Bank's Sørensen said Italy avoiding a downgrade should have a "positive impact" on Italian bonds. Moody's is set to update its sovereign rating for Italy on Friday.
Italy's 10-year yield was up 2 bps at 4.191%, pushing the closely watched 10-year yield gap between Italian and German bonds tighter by around 2 bps at 187 bps.
Markets will need to digest increasing government bond supply this week, with issuance expected from France, Spain, Germany, Finland, Greece and Slovakia, in both nominal and inflation-linked bonds.
Elsewhere, investors will be keeping an eye on U.S. debt ceiling negotiations, with President Joe Biden expected to meet with congressional leaders on Tuesday for talks on raising the debt ceiling and avoiding a default.
Short-term U.S. Treasury yields have risen to their highest
on record as the federal government's 'X-date', the date when
they could run out of cash to pay their obligations, comes into
view, with the 1-month Treasury-bill yield hitting
5.827% last week.
(Reporting by Samuel Indyk; Editing by Jacqueline Wong)
