UPDATE 2-German bond yields jump as investors nose out of safe havens

·3 min read

(Updates prices)

By Harry Robertson

LONDON, March 27 (Reuters) -

German government bond yields rose on Monday, going against this month's trend, as fears about banking turmoil eased and traders bet that the European Central Bank will raise interest rates further.

Germany's 2-year bond yield, which is highly sensitive to changes in interest rate expectations, was last up 14 basis points (bps) to 2.51%. Bond yields rise when prices fall, and vice versa.

The 2-year yield has tumbled since the start of March, when it stood at a 14-year high of 3.385%. It fell 12 bps on Friday.

Two major bank failures in the U.S. and the emergency takeover of Credit Suisse in Europe have knocked market confidence, sending investors to the safety of bonds and causing a major reversal of bets on how high central banks can now lift interest rates.

The mood brightened somewhat on Monday, however, after First Citizens BancShares Inc bought all the loans and deposits of failed U.S. lender Silicon Valley Bank. Europe's STOXX banking index was last up 1.5%.

Germany's 10-year bond yield was up 9 bps at 2.22%, although still well below the more than 11-year high of 2.77% reached earlier this month.

"It's just the ebb and flow of banking related concerns as the market tries to determine how concerned it should be as regards the recent stresses," Richard McGuire, head of rates strategy at Rabobank, said.

Also on Monday, data showed that German business morale unexpectedly rose in March, adding to signs that Europe's largest economy is stabilising despite the jitters in the banking sector.

According to volatile pricing in derivatives markets, traders on Monday saw around a 65% chance that the ECB will raise interest rates by 25 bps in early May and a 35% chance it will leave them on hold. The ECB raised rates 50 bps to 3% earlier this month.

Market pricing now indicates a peak or "terminal" ECB interest rate of around 3.4% in September,. That was an increase from Friday, when a peak of around 3.25% was expected to be reached in August.

Yields on Italian government bonds, seen as the benchmark for the euro zone's weaker "periphery" economies, also rose.

The Italian 10-year yield climbed 4 bps to 4.05%. That caused the closely watched gap between Italian and German borrowing costs to narrow to 183 bps.

"It seems like the market has opened in a more positive mood and you are repricing higher," said UBS rates strategist Emmanouil Karimalis. He said UBS expects rates to peak at 3.5% in June.

"In my view, given the elevated uncertainty ... I don't see a materially higher repricing of the terminal rate, at least to the peak levels (of more than 4%) that we saw earlier this year," he said.

Euro zone inflation data for March, due out Friday, will factor strongly into any ECB decision.

Economists polled by Reuters expect the headline year-on-year inflation rate to have cooled to 7.2% from 8.5% in February. But they see the core rate - which strips out volatile food and energy prices - hitting a new record of 5.7%. ECB policymaker and Portuguese central bank Governor Mario Centeno said on Monday that wage growth in the euro zone was not fuelling inflation.

Fellow ECB policy maker, Spain's Pablo Hernandez de Cos, said the central bank will take into account both the risks in the banking sector and the evolution of core inflation for the future path of interest rates.

(Reporting by Harry Robertson, additional reporting by Alun John, editing by Andrew Heavens)