Euro zone govt bond yields rise as US CPI keeps rate hike in play

Euro zone government bond yields rose on Thursday after annual U.S. consumer price inflation unexpectedly held steady in August, lifting market bets that the Federal Reserve could hike interest rates again before the end of the year.
 

In the 12 months through September, the consumer price index advanced 3.7%, the same margin as in August but down from a peak of 9.1% in June last year. Economists polled by Reuters had forecast the CPI climbing 3.6% year-on-year.
 

Core consumer prices, which strip out volatile energy and food components, gained 4.1%, down from 4.3% the month before.

"In short, the report reminded us that the path to 2% inflation is unlikely to be smooth sailing and the Fed must continue to err on the side of doing too much rather than too little," said Bank of America global research U.S. economist Stephen Juneau, who forecasts a rate increase in November.
 

Markets still place a near 90% chance that the Fed keeps its key interest rate unchanged next month, according to the CME's FedWatch tool. However, traders raised their expectations for a hike by December to around 40%, from around a 28% chance the day before.
 

Germany's 10-year bond yield - the benchmark for the euro zone - rose 6.5 basis points (bps) to 2.784% after the data, having earlier been at 2.687%, the lowest since Sept. 22.
 

The Italian 10-year bond yield was up 9.5 bps at 4.759%, after falling to its lowest since Sept. 25 at 4.631% earlier on Thursday.

Minutes from the European Central Bank's September meeting, released on Thursday, showed a division among policymakers when they opted to raise the deposit rate to a record 4%, but signalled an end to the tightening cycle.
 

"The debate was indeed more heated than before, with views on inflation and the policy rate diverging more and some members having been in favour of a pause," Carsten Brzeski, global head of macro at ING, said.
 

"As much as the ECB has tried to keep the door to further rate hikes open since the September decision, recent developments have clearly complicated its position," Brzeski added, citing higher oil prices and dampened growth prospects.
 

Germany's 2-year bond yield, which is sensitive to changes in interest rate expectations, was 5.5 bps higher at 3.156%.

Minutes from the Federal Open Market Committee's (FOMC) last meeting, released on Wednesday, showed officials adopted a relatively cautious stance in September, despite suggesting at the time that one more rate hike was likely.
 

"The minutes revealed that several members considered that the policy rate is likely to be at or close to its peak," said Jussi Hiljanen, head of rates strategy at lender SEB.
 

The U.S. 10-year Treasury yield - which sets the tone for other bond yields around the world - has dropped around 28 bps since surging to a 16-year high of 4.887% last week.
 

Analysts say a number of factors have been pushing bond yields lower, including central bank officials talking down the need for further interest rate increases, and nervousness about the Israel-Hamas conflict spreading more widely in the Middle East.

The closely watched gap between German and Italian 10-year bond yields was 2.5 bps wider at 197 bps on Thursday. It hit its widest since January last week at 209.2 bps.
 

ECB policymaker Yannis Stournaras told Reuters that the ECB should not stop its bond purchases early because they may still be needed to calm jittery markets. Yet he said it is down to governments, including Italy's, to keep investors on side.