The European bond market is on track for its worst month on record as investors have been betting on massive rate hikes by the European Central Bank and the Bank of England at a time of unprecedented inflation.
The region’s high-quality government and corporate debt market fell 5.3 percent in the month to Tuesday, the largest decline since the Bloomberg Pan-European Aggregate Total Return Index began in 1999. The decline was broad, with UK, German and French debt all hit by heavy sales in a reversal of July profits.
The continent’s bond markets have been shattered as investors brace for more aggressive central bank rate hikes in the face of rising food and fuel prices following Russia’s war in Ukraine.
Sales gained momentum on Wednesday after a new round of data showed euro area consumer price growth hit a record high of 9.1 percent in August. The report underlined how high inflation is becoming more and more entrenched in the economy.
The higher-than-expected inflation rate is putting further pressure on the ECB to accelerate the pace of rate hikes when policymakers meet in September. The central bank raised its key interest rate in July for the first time in more than a decade, but economists expect it will have to pursue further hikes in the fight against intense inflation. The BoE is making a similar effort to contain rising inflation in Britain, which is at its highest level in more than 40 years.
“The only factor driving bond yields higher in August was the explosion in energy prices in Europe,” said Antoine Bouvet, senior interest rate strategist at ING.
This month, investors raised their expectations of ECB and BoE rate hikes as energy prices continued to rise. Markets expect ECB borrowing costs to reach 2.1 percent in March from zero currently, while the BoE is priced to raise interest rates to 4.1 percent in March from current levels of 1.75 percent, according to data from Bloomberg based on money market pricing.
“Obviously the hawks have the momentum in their favor,” Bouvet said.
The president of the German central bank, Joachim Nagel, has said that rising inflation is “a strong” [ECB] interest rate hike in September.
Analysts at JPMorgan, Goldman Sachs and Bank of America all said on Wednesday they now expect the ECB to raise interest rates by 0.75 percentage points at next week’s meeting in a bid to cool inflation. The last time the central bank raised its deposit rate by such a large margin was in 1999.
“Even if inflation peaks, central banks will remain aggressive,” said Richard McGuire, Rabobank’s head of interest rate strategy.
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The yield on the German 10-year Bund rose by more than 0.7 percentage point to 1.54 percent in August, the biggest monthly jump since 1990. The yield on 10-year British government bonds has risen from 1.8 percent at the beginning of August. August, up 2.8 percent on Wednesday.
The prospect of high borrowing costs has also raised concerns about a potential recession in Europe and the UK next year, with some expecting central banks to be forced to cut interest rates in the spring.
“Everything is aligned in the same direction and it’s all a disaster for the consumer,” McGuire says.
Additional reporting by Ian Johnston