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UPDATE 2-German bond yields trim losses, peripheral borrowing costs jump

·2-min read

* Euro zone periphery government bond yields http://tmsnrt.rs/2ii2Bqr (Recasts, adds comment)

By Stefano Rebaudo

MILAN, June 18 (Reuters) - German government bond yields recovered some losses while peripheral borrowing costs jumped on Friday, tracking an upward move in U.S. Treasuries after comments about U.S. inflation by a Federal Reserve official.

"It's natural that we've tilted a little bit more hawkish here to contain inflationary pressures," St. Louis Federal Reserve bank President James Bullard said on CNBC, after mentioning more intense than expected inflation.

Bullard is one of seven Fed officials who forecast a rate increase in late 2022. Thirteen out of 18 policymakers foresaw a "liftoff" in borrowing costs in 2023 at the Fed policy meeting on Wednesday.

U.S. 10-year government bond yields recovered some earlier losses and were down 1 basis point at 1.5%.

"Fed’s Bullard made clear the debate about a Fed tapering will continue, while he sees a first rate increase in late 2022, triggering a new selloff in government bonds," Andrea Ponti, co-head fixed income portfolio management at Kairos Partners, said.

"Italian bond prices, which are credit-sensitive, are underperforming," he added.

Germany's 10-year government bond yield, the bloc's benchmark, was down 1 basis points at -0.20%.

The first bond backing the EU's COVID-19 recovery fund issued on Wednesday continued to outperform the same maturity Bund, with yields falling 5 bps to 0.043%.

Unicredit analysts said that "after a turbulent week, we expect the next several days to see a modest increase in U.S. real rates, to which euro zone government bond yields should remain rather immune."

Periphery bond prices continued to underperform core bonds as they have benefited most from the ultra-accommodative monetary policy to avoid the pandemic's adverse economic impact.

Italy's 10-year government bond yield was up 4.5 bps at 0.872%. Portugal 10-year yields rose 2 basis points to 0.433%.

Semi-core bonds, such as France’s OAT, were flat at 0.16%.

On the U.S. front, the "capitulation of 10y TIPS break-evens to the lowest level since end-March amid steady real yields is leaving inflation expectations as (Fed chair Jerome) Powell's major victim," Commerzbank analysts said.

They seem "misguided in the current situation", they added.

According to Deutsche Bank economist George Saravelos, this notable drop in U.S. inflation expectations coupled with a fall in nominal yields "is telling us that the market is taking an extremely pessimistic view on real neutral rates".

"If the Fed decides to go early, the market is saying it won't be able to go very far before inflation and growth hit a speed limit, pushing yield expectations after the initial hike lower," Saravelos said in a research note.

(Reporting by Stefano Rebaudo; Editing by Jan Harvey)

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