European debt market hit by historic selloff after rate hike bets

The European bond market is on course for its worst month on record as investors bet on big rate hikes from the European Central Bank and the Bank of England at a time of unprecedented inflation.

The region’s market for high-quality government and corporate bonds fell 5.3% in the month ending Tuesday, the biggest drop since the Bloomberg index began Pan-European Aggregate Total Return in 1999. The decline was wide, with UK, German and French debt all hit by heavy selling in a reversal of July’s gains.

Bond markets across the continent have been hit as investors brace for more aggressive central bank rate hikes in the face of soaring food and fuel prices sparked by Russia’s war in Ukraine.

The sell-off accelerated on Wednesday after a fresh set of data showed the rate of consumer price growth in the euro zone hit a record high of 9.1% in August. The report underscores how high inflation is embedding itself more broadly across the economy.

The higher-than-expected inflation figure puts additional pressure on the ECB to accelerate the pace of interest rate hikes at the next policymakers’ meeting in September. In July, the central bank raised its main interest rate for the first time in more than a decade, but economists expect it will have to continue its increases as it battles intense inflation. The BoE is engaged in a similar effort to stifle soaring inflation in Britain, which is at its highest level in more than 40 years.

“The only factor that pushed bond yields higher in August was the explosion in energy prices in Europe,” said Antoine Bouvet, senior rates strategist at ING.

This month, investors strengthened their expectations for interest rate hikes from the ECB and BoE as energy prices continued to rise. Markets expect ECB borrowing costs to hit 2.1% by March from zero currently, while BoE plans to hike rates to 4.1% in March from low current 1.75%, according to Bloomberg data based on money market prices. .

“Obviously the Falcons have the momentum in their favour,” Bouvet said.

German central bank president Joachim Nagel said soaring inflation will require “strong [ECB] rise in interest rates in September”.

Analysts at JPMorgan, Goldman Sachs and Bank of America all said on Wednesday they now expect the ECB to hike rates by 0.75 percentage points at next week’s meeting in an attempt to calm the tide. ‘inflation. The last time the central bank raised its deposit rate by such a margin was in 1999.

“Even if inflation goes past its peak, central banks are going to remain hawkish,” said Richard McGuire, head of rates strategy at Rabobank.

The yield on the benchmark 10-year German Bund rose more than 0.7 percentage points to 1.54% in August, its biggest monthly jump since 1990. The yield on the UK 10-year gilt rose 1 .8% at the beginning of August. , at 2.8% on Wednesday.

The prospect of high borrowing costs has also raised concerns about a possible recession in Europe and the UK next year, with some expecting central banks to be forced to cut interest rates in spring.

“It’s all aligned in the same direction and it’s all catastrophic for the consumer,” McGuire said.

Additional reporting by Ian Johnston

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