Battered euro zone bond markets fought back on Wednesday, with sovereign borrowing costs down sharply for a second straight session as investors scaled back their most aggressive bets for interest rates hikes in the coming year.
European Central Bank chief Christine Lagarde said a rate rise next year is very unlikely as inflation remains too low, prompting a key market gauge of long-term euro zone inflation expectations to retreat further from recent highs above 2% .
Disappointment that Lagarde did not push back more firmly against aggressive market pricing of rate hikes after last Thursday's ECB meeting had triggered a fresh sell-off in bond markets that sent borrowing costs to new multi-month highs.
But a calmer tone has emerged with the latest ECB talk and this week's Australian central bank meeting bringing some restraint to investors' more aggressive thinking on the rate outlook for major economies.
The Reserve Bank of Australia took a major step on Tuesday towards unwinding extraordinary pandemic stimulus, but pledged patience and rejected market talk of an early rate hike.
European money markets now price in a 10-basis-point rate hike by October 2022. At the start of the week, market pricing had pointed to a 10-bps- move by July 2022, and two hikes by October.
Germany's 10-year Bund yield fell to a one-month low at -0.19%, below roughly 2-1/2 year highs hit last week at -0.064%. And 30-year Bund yields fell six basis points to a two-month low at 0.117%.
"As the dust settles, there's a clearer look at whether the ECB will hike next year, and markets are coming to the realization that even if inflation rises above target next year, they [the ECB] might not act so fast," said DZ Bank rates strategist Rene Albrecht.
"I think the market is realizing that it was getting ahead of itself and the positioning is cleaner."
Bond markets have become more volatile in recent months, with yields swinging sharply as investors try to assess the outlook for inflation and ECB policy.
Having shot up last week, Italian 10-year bond yields, for instance, fell 13 basis points on Tuesday in their biggest one-day fall since May 2020.
They fell a further 6 bps on Wednesday to 1.02%, having touched more than one-year highs near 1.29% on Monday.
"We are having this massive to and fro on policy expectations and that will probably continue as we have the Fed this evening and the BoE (Bank of England) tomorrow," said Rabobank senior rates strategist Lyn Graham-Taylor.
The U.S. Federal Reserve is expected to conclude a two-day meeting on Wednesday with a decision to taper its $120 billion-a-month asset purchase program by around $15 billion a month.
© 2022 Thomson/Reuters. All rights reserved.