April 20, 2018 / 11:31 AM / a year ago

UPDATE 2-German yields set for biggest weekly rise since early Feb after oil surge

* Long-term inflation expectations highest since mid-March

* BoE’s Carney dampens UK rate hike expectations

* Euro zone periphery govt bond yields - tmsnrt.rs/2ii2Bqr (Updates prices, adds Draghi speech, quote)

By Abhinav Ramnarayan

LONDON, April 20 (Reuters) - German government bond yields were set for their biggest weekly rise since the beginning of February after a surge in oil prices forced inflation expectations and euro zone bond yields higher.

Euro zone bond yields hit fresh highs on Friday and are now well above their levels at the start of the week after a sharp sell-off prompted by Brent crude prices hitting their highest in more than three years at $74.75 a barrel on Thursday.

This prompted a tweet from U.S. President Donald Trump in which he said oil prices were “articifially very high” and “will not be accepted”.

Higher oil prices tend to push up inflation, which strengthens the case for tighter monetary policy and higher interest rates.

The yield on Germany’s 10-year government bond, the benchmark for the region, hit a five-week high of 0.613 percent and is about 10 basis points (bps) higher this week, having fallen in seven of the past 10 weeks.

French and Dutch equivalents were also set for their biggest weekly rises in 10 weeks.

“The market is hoping that higher oil prices will lead to higher inflation in a sustainable manner,” said DZ Bank strategist Sebastian Fellechner.

“But this is hard to say because oil prices are only one factor; we need confirmation, we need to see other factors kick in, such as wage growth.”

Still, a market gauge of long-term euro zone inflation expectations, the five-year five-year forward inflation-linked swap, was close to its highest level since mid-March, hit on Thursday at 1.6898 percent.

The sell-off in bonds this week comes after a long stretch in which euro zone yields were kept compressed by factors including the possibility of a trade war between the United States and other major world economies, China in particular.

As G20 policy meetings get under way, this is likely to be a major topic for discussion ahead of next week’s European Central Bank meeting, Commerzbank analysts said in a note.

Japan has warned its G20 counterparts that protectionism and exchange of retaliatory measures will disrupt financial markets and heighten volatility.

In a speech on Friday, ECB president Mario Draghi said the euro zone economy needs strong global growth and open trade if it is to continue to prosper.

Large redemptions this month have also played a role in keeping yields lower, and this is set to continue next week with French coupon and redemptions alone worth 37.3 billion euros, the Commerzbank analysts said.

Also on Friday British borrowing costs dropped after Bank of England Governor Mark Carney dampened expectations of a May increase to UK interest rates.

The yield on 10-year Gilts was 3 bps lower while two-year Gilts were down 6 bps on the day.

Later on Friday Moody’s is scheduled to review Portugal’s rating and market participants are looking to see if the Iberian country regains its third major investment grade rating.

“For Portugal, we might get some small mechanical buying off the back of this,” said Rabo Bank rates strategist Lyn Graham-Taylor. (Reporting by Abhinav Ramnarayan and Fanny Potkin Editing by David Goodman )

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