By Abhinav Ramnarayan
LONDON, Oct 26 (Reuters) - Euro zone inflation expectations among bond investors opened at a new seven-year high on Tuesday, shooting past the European Central Bank's target on the back of soaring oil prices and supply chain crunches across the world.
Oil prices reached multi-year highs this week as tight global supply and strengthening fuel demand supported prices.
This adds to several months of high inflation readings in the euro zone and beyond, leading to speculation that the ECB's pandemic-era stimulus is unsustainable.
An important market gauge of long term euro zone inflation expectations, the five-year, five-year forward inflation swap, opened on Tuesday at 2.0284%, its highest since September 2014 and higher than the ECB target of 2%.
"Rising inflation swaps will be a key topic at Thursday's ECB meeting," analysts at ING wrote in a note. "The persistent inflation scare is seeing expectations tilt towards tighter policies, and any pushback by the ECB may remain confined to the very front-end pricing."
Euro zone government bonds yields, while relatively unchanged on Tuesday, have risen sharply in recent weeks with persistently higher consumer prices leaving investors with little choice but to price in tighter policy.
Germany's 10-year bond yield, the benchmark for the bloc, is 30 basis points higher at -0.11% compared to where it was two months ago.
So far, most euro zone yields have risen more or less in sync with each other. Italy, one of the lowest rated countries in the euro zone, has seen its bond yield spread over Germany remain more or less steady between 100 and 110 bps.
But analysts question whether this is sustainable, with ratings agency S&P Global suggesting last week that the country's positive ratings outlook is partly dependant on ECB support.
"Sovereign spreads are likely the most vulnerable should there be any shift in focus towards any larger-than-anticipated scaling down of ECB purchase programmes – in size or flexibility," the ING analysts said.
Among the supply scheduled for Tuesday, Italy is selling a 30-year inflation-linked bond through an auction, in addition to a three-year nominal bond. Germany and Netherlands are also selling short-dated debt via auctions. (Reporting by Abhinav Ramnarayan, Editing by Timothy Heritage)