UPDATE 3-Euro zone yields jump on inflation fears, ahead of Fed minutes

·2 min read

(Updates rates)

By Stefano Rebaudo

Aug 17 (Reuters) - Euro zone government bond yields rose on Wednesday as double-digit UK inflation data shifted investors' focus back to potential further monetary tightening in the euro area.

Investors were also awaiting minutes of the U.S. Federal Reserve's most recent meeting, due out at 2 p.m. EDT (1800 GMT), which might provide additional hawkish signals.

Germany's two-year government bond yields, which are sensitive to rate hike expectations, rose 15 basis points (bps) to 0.72%, the highest since July 21. The 10-year yield was up 10 bps to 1.08%, at its highest since July 22.

"Rates rose in the last couple of days due to a combination of fears of higher inflation and repositioning of portfolios after a bond rally, which started in mid-June," said Annalisa Piazza, research analyst at MFS Investment Management.

"Bund yield levels are close to their fair values; but we still see some risks of overshooting with inflation data remaining the main driver," she added.

British consumer prices jumped to 10.1% in July, the highest since February 1982.

Matthew Ryan, head of market strategy at Ebury highlighted that UK "core inflation also came in much hotter than expected (6.2%), providing another worrying confirmation that the surge in prices is not being driven solely by the increase in energy".

Central banks are concerned about second-round effects, when increases in wage growth and long-run inflation expectations push up inflation persistently.

The Fed minutes should shed more light on the U.S. interest rate trajectory. Fed officials recently said they were open to the possibility of a bigger than 50 bps hike in September.

"The question is whether the Fed wants to use these minutes as a communication tool to push back against the view of a 2023 easing cycle," ING analysts said in a note to clients.

"Post-meeting rhetoric from the Fed suggests this is more likely to be the case," they added.

Nikko Asset Management's chief global strategist John Vail highlighted, however, that "whereas Fed fund futures once predicted cuts in the first half, now a hike is partially priced in, while 2023 only predicts less than one 25 bps cut".

Italy's 10-year government bond yield rose 16.7 bps to 3.30%, hitting an almost three-week high.

The spread between Italian and German 10-year yields widened to 223 bps, a two-week high, after bottoming out at around 200 bps earlier this week.

In July, the Italian government led by Mario Draghi collapsed, and the spread widened to about 260 bps.

It then tightened as fears eased that the country could distance itself from the European Union if the conservative alliance wins the Sept. 25 election, and after ECB support for peripheral bonds in July. (Reporting by Stefano Rebaudo, additional reporting by Joice Alves; Editing by Catherine Evans and David Evans) ;))