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German yields hit multi-week highs as producer prices surge

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German bond yields surged on Friday after data showed the biggest jump in producer prices on record in the euro zone’s biggest economy, stoking inflation concerns.

Producer prices in July in Germany leapt 37.2% from the same time last year and 5.3% from June, compared to the 0.6% monthly rise expected in a Reuters poll.

Germany’s 10-year government bond yield, the benchmark for the euro area, rose as much as 14 bps to 1.242%, the highest in four weeks.

The two-year yield, which is more sensitive to interest rate expectations, rose as much as 9 bps to 0.849%, the highest since June 29.

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Viraj Patel, global macro strategist at Vanda Research, said the data “reinforces Europe stagflation fears and the bond market is scared of sticky inflation.”

Bond markets have been caught in a tussle, particularly in the euro zone, between fears of a looming recession and red-hot inflation, which unexpectedly rose to another record high in July.

After a sharp fall earlier in the summer driven by recession fears, bond yields have risen particularly sharply this week as investors have started increasing their bets on European Central Bank rate hikes again.

Germany’s 10-year yield, for example, set its biggest weekly rise since early June, up 24.5 bps this week.

Money markets have moved to price in not only a full probability of a 50 bp hike from the European Central Bank in September, compared to a 50% chance of such a move priced in early August, but also a small probability of a 75 bp move at that meeting.

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Since last week they have also moved to price in around 15 bps of additional ECB hikes by December, and bets on how far the ECB will hike in this cycle have also risen, to a terminal rate of 1.8%, from around 1.4% last week.

“The market narrative has changed from growth fear to inflation fear… that means that, with (ECB board member Isabel) Schnabel signaling that they may be okay to tighten into a recession, the ECB is perceived more aggressively,” said Piet Christiansen, chief analyst at Danske Bank.

Schnabel on Thursday said the inflation outlook for the euro zone has failed to improve since July’s rate hike, suggesting she favored another large rate increase in September following July’s 50 bps move.

A market gauge of long-term euro zone inflation expectations hit a fresh 7-1/2 week high at 2.18% on Friday..

Ten-year yields in Italy, among the biggest beneficiaries of ECB stimulus, rose as much as 17.5 bps to 3.53%, the highest since July 28, widening the closely-watched spread over German peers to 225.5 bps, the widest since Aug. 3.

They also set their biggest weekly rise since early June, up 42 bps this week. (Reporting by Yoruk Bahceli, additional reporting by Stefano Rebaudo; Editing by Susan Fenton)

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