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UPDATE 2-German yields eye biggest jump since Mar 2020

·3 min read

(Adds details, updates prices)

By Yoruk Bahceli

July 7 (Reuters) - Benchmark German bond yields were set for their biggest daily rise since March 2020 on Thursday as the U.S. Federal Reserve's meeting minutes and Chinese stimulus reports added to the tussle between inflation and recession fears gripping markets.

Minutes of the bank's June meeting showed officials rallied around the outsized 75 basis-point hike and a firm restatement of intention to get prices under control, with many judging there was a significant risk that elevated inflation could become entrenched if the public started to question the bank's resolve.

Following overnight moves that saw U.S. Treasury yields end the session 11-15 basis points higher, also driven by economic data, euro zone yields followed suit on Thursday. U.S. yields continued higher on Thursday.

Jens Peter Sorensen, chief analyst at Danske Bank, said the minutes had driven bond yields higher as they "showed an aggressive Federal Reserve, where the need to curb inflation is the main focus as the minutes focused on inflation rather than the risk of a recession".

After touching five-week lows on Wednesday at 1.072%, Germany's 10-year yield, the benchmark for the euro area, was up 14 basis points on the day to 1.29% by 1504 GMT, set for the biggest daily rise since March 2020.

The two-year yield was up 15 bps to 0.53%, having dropped as low as 0.27% on Wednesday.

Italy's 10-year yield rose 12 bps to 3.36%, the highest in nearly a week. Greece's 10-year yield rose 29 bps. A trader said the outsized move was technical and reflected a "normalisation" of the spread with Italian bonds.

Yields extended their rise following a Bloomberg story which, citing unnamed sources, said China was considering allowing local governments to sell $220 billion of special bonds in the second half of the year to shore up the economy.

Sources told Reuters on Tuesday China would set up an investment fund worth $75 billion to spur infrastructure spending and revive a flagging economy. "I think these headlines about Chinese stimulus is helping alleviate some of the macro gloom and putting bonds yields on an upward path," ING senior rates strategist Antoine Bouvet, said.

Investors also digested the accounts of the European Central Bank's June meeting showing policymakers debated flagging a larger interest rate hike for July, and also remarks from ECB policymaker Francois Villeroy de Galhau who said plans to keep bond spreads from unjustifiably widening would get off the ground.

The yield spread between 10-year German and Italian bonds - a gauge of the euro area financial stability - was last broadly steady at 205.9 basis points.

At the June meeting, the ECB announced an end to bond buys and said it would kick off rate hikes with a 25-bps move in July. A potential anti-fragmentation tool to reduce an "unwarranted" divergence between member states' borrowing costs was not announced until a week later.

"Markets should treat this as old news and remain focused on gas supply fears and recession risk," Hauke Siemssen, rates strategist at Commerzbank, said.

"Whether the ECB will be able to deliver the envisioned hikes in September and beyond should thus largely depend on the future of gas deliveries and prospects of a recession."

Facing those risks, Money markets have ramped down bets on ECB hikes sharply. They now price in 145 bps of hikes by December, compared with 190 bps in mid-June, and a terminal rate of around 1.50% in late 2023, down from around 2.6%. (Reporting by Yoruk Bahceli Additional reporting by Danilo Masoni in Milan and Lefteris Papadimas in Athens Editing by Angus MacSwan, Peter Graff and Andrew Heavens)