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LONDON (Reuters) - Short-term borrowing costs in Germany hit five-week highs on Friday on comments from ECB policymaker Ewald Nowotny that the bank could raise interest rates before the end of bond-buying stimulus in the bloc.
The Austrian central bank governor told a newspaper on Thursday that the European Central Bank (ECB) would decide later whether to raise interest rates before or after ending its bond-buying scheme. He said the ECB could hike its deposit rate, currently below zero, before the main rates at which it lends to banks.
Nowotny's remarks come just a week after the ECB signalled a diminishing urgency for policy action. Reports that some ECB officials had discussed the possibility of rate hikes have also jolted a bond market that has for years been underpinned by ultra-easy monetary policy.
Globally, central banks are beginning to move towards tighter policy.
The U.S. Federal Reserve hiked rates on Wednesday for the second time in three months while China's central bank raised short-term rates on Thursday. The same day, a Bank of England meeting ended with one policymaker voting for a rate rise.
"When you connect the dots it almost appears as if central banks can sense that sentiment is sufficiently positive for them to start normalising monetary policy," said Richard McGuire, head of rates strategy at Rabobank.
Investors on Friday ratcheted up their expectations for when the ECB will raise interest rates. Money markets show around an 80 percent chance of a move in December -- up from 60 percent a week ago.
German two and five-year bond yields scaled five-week highs at around minus 0.69 percent and minus 0.36 percent respectively. Though they settled back down as the session wore on, the 2-year bond yield was still up 2 basis points at minus 0.80 percent and the five-year was higher on the day at minus 0.42 percent.
Meanwhile, the France/Germany yield spread hit a two-week high on opinion poll gains for far-right leader Marine Le Pen.
The gap between France and Germany's 10-year borrowing costs rose to a two-week high of 67 basis points.
A poll showing French presidential candidate Le Pen had extended her first-round lead over centrist candidate Emmanuel Macron helped push yields on safe-haven German Bunds a touch lower as well.
France elects its next president in two rounds of voting in April and May.
Nowotny's comments also rippled through currency markets, with the euro touching five-week highs against the dollar.
"The market has been listening to the ECB's forward guidance for a long time and pricing that in," said Peter Chatwell, head of European rates at Mizuho. "So now to hear a different tune from the ECB inevitably means there has to be a change in markets."
The ECB has been under pressure to start scaling back its massive bond-buying stimulus as economic growth and inflation pick up.
But with underlying price pressures still subdued and the region facing elections in big economies France and Germany, the central bank faces a delicate balancing act.
Analysts said raising the minus 0.40 deposit rate before ending QE could be one way for the ECB to ease that pressure without having a major impact on overall monetary tightening.
"It is possible that the ECB could raise the depo rate before QE ends," said Lorenzo Codogno, chief economist at LC Macro Advisors. "It would have a signalling effect and, more importantly, deflate some of the pressure to start scaling back QE."
Additional reporting by Abhinav Ramnarayan; Editing by Julia Glover