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Yoruk Bahceli and Dhara Ranasinghe

Euro zone bond yields soared on Thursday after the European Central Bank said it plans to end bond buying in the third quarter, as surging inflation outweighs the risks to economic growth from Russia’s invasion of Ukraine.

Bond yields in Italy, a key beneficiary of ECB bond buying stimulus, surged over 20 basis points and German 10-year yields hit three-week highs – more than unwinding falls since Russia’s invasion of Ukraine on Feb. 24.

As risk-off sentiment gripped world markets, the euro and stocks weakened, failing to benefit from the surprisingly hawkish tone from the ECB.

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The ECB said bond purchases under the conventional Asset Purchase Programme would be smaller than previously planned and would end in the third quarter depending on economic data.

It raised its inflation projections while cutting its growth outlook.

“Lagarde may be claiming maximum optionality and that today’s adjustments aren’t tightening, but the actual message is hawkish,” said Arne Petimezas, a senior analyst at AFS Group.

“They are tapering a lot faster. And what Lagarde is really saying is: ‘we’re going to hike, unless inflation is not too bad or something really goes wrong in markets’.”

Germany’s two-year yield, sensitive to interest rate expectations, rose more than 17 bps to -0.35% as traders ramped up rate hike bets. Five-year yields turned positive for the first time since Feb. 28, and 10-year Bund yields rose to 0.30%, the highest since Feb. 16 .

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The ECB noted that adjustments in interest rates will take “some time” after bond purchases end and would be “gradual.”

Still, money markets moved to price in 45 bps of ECB hikes by December, versus 35 bps before the ECB decision and brought forward bets on a first, 10 basis-point hike to July, compared with September before the decision.


The most eye-popping moves were in Italy, where two-year yields were last up 21 bps at 0.18%, having been as low as -0.05% earlier on Thursday.

Italy’s 10-year yields rose 24 bps to 1.92%, pushing the Italian/German yield gap to as high as 162 bps from around 150 bps before the meeting.

“Rates are right to jump, and in particular in the periphery where the (spread) tightening seen since the start of the war in Ukraine was premised on delayed ECB normalization,” said ING senior rates strategist Antoine Bouvet.

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A key market gauge of long-term euro zone inflation expectations dropped to as low as 2.05% from nearly 2.16% earlier on Thursday.

The euro meanwhile fell, giving up initial gains after the ECB statement. It was down 0.5% at $1.1017, with the dollar gaining ground as latest U.S. inflation numbers confirmed expectations for a Federal Reserve rate hike next week.

Euro zone stocks fell 1.4%, banking stocks tumbled 2.6% and the spread on the iTraxx crossover Europe index, which measures the cost of insuring exposure to a basket of underlying European junk corporate bonds, widened as much as 13 bps to 383 bps.

“We still forecast only one 25bp (ECB) rate hike this year, most likely in December, but a scenario of accelerated tightening in 2023 is likely to gain momentum assuming the euro area can avoid recession,” said Pictet Wealth Management strategist Frederik Ducrozet.

(Reporting by Yoruk Bahceli and Dhara Ranasinghe, additional reporting by Danilo Masoni, Saikat Chatterjee and Joice Alves; Editing by Andrew Heavens, Jonathan Oatis and Alison Williams)

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