By Stefano Rebaudo
(Reuters) -Euro zone bond yields fell on Friday after a European Central Bank (ECB) policymaker flagged recession risks and investors grew wary of pricing in more aggressive monetary tightening.
The ECB is prepared for a possible technical recession paired with high inflation, Vice-President Luis de Guindos said.
Investors will also focus on gilts after reports that British Prime Minister Liz Truss’s government is considering a U-turn on some of the measures in its late-September “mini-budget”.
Truss and her finance minister Kwasi Kwarteng are “determined and resolute” to deliver their economic plans that have caused turmoil in markets, junior trade minister Greg Hands said.
“Investors are waiting to understand what will happen in the UK as a rise in gilt volatility will spread to the euro area,” said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.
“Of course, de Guindos mentioning recession risks strengthens the view that the ECB will have to soften its stance.”
Yields on British 10-year gilts were down 25 basis points (bps) at 3.94%.
Germany’s 10-year government bond yield, the benchmark for the euro zone bloc, fell 10 bps to 2.18% after dropping 4.5 bps the day before. It hit its highest level since August 2011 at 2.423% on Wednesday.
“Euro area yields dropped late yesterday despite strong U.S. inflation data with investors not willing to bet on more monetary tightening,” Allianz Global Investors’ Maxia added.
U.S. consumer prices increased more than expected in September as rents surged by the most since 1990, but the numbers were not enough to push investors to price in more ECB monetary tightening and yields fell late on Thursday.
“Bond yields are close to their peak,” said Joost van Leenders, senior investment strategist at Van Lanschot Kempen.
“We think there are no reasons for significant rises as we expect the ECB to pause its tightening path next year due to a weak economy,” he added.
Mizuho rate strategists reckoned that further inflation prints are needed before confirming a rise of the neutral rate – the interest rate that supports the economy at full employment while stabilising inflation.
Analysts have flagged some concerns about supply in government bond markets, with euro zone countries expected to increase public spending to fight the adverse impact of surging energy prices.
ECB policymakers discussed earlier this month a detailed timeline for running down a 3.3 trillion euro ($3.2 trillion) bond portfolio and envisioned the start of so-called quantitative tightening sometime in the second quarter of 2023, sources told Reuters this week.
But Bank of America expects euro zone net government bond supply to rise close to a record high of 400 billion euros next year.
($1 = 1.0253 euros)
(Reporting by Stefano Rebaudo Editing by Ana Nicolaci da Costa and Mark Potter)