February 8, 2018 / 11:43 AM / 10 months ago

Euro zone yields creep higher on German and U.S. spending prospects

LONDON (Reuters) - Euro zone government bond yields hit multi-year highs on Thursday as a budget agreement in the United States and a coalition deal in Germany pointed to higher spending on both sides of the Atlantic.

Germany’s pro-spending Social Democrats (SPD) are set to head the finance ministry in a coalition government, while U.S. Senate leaders reached a deal on Wednesday to raise spending on military and domestic programmes by almost $300 billion over the next two years.

With two of the world’s largest economies now expected to loosen the purse strings in the coming years, investors are watching to see if rate setters expect to tighten monetary policy as a result.

“SPD getting the finance ministry (in Germany) means more social expenditure and perhaps also a less restrictive stance on southern Europeans,” said DZ Bank strategist Daniel Lenz.

European bond yields’ rise towards multi-year highs accelerated at midday after the Bank of England signalled interest rates probably need to rise sooner and by a bit more than it thought three months ago.

Germany’s 10-year government bond DE10YT=RR, the benchmark for the bloc, scaled a two-year peak of 0.777 percent on the news.

UK government bonds also rose on the Bank of England decision, while most euro zone bond yields were up by 1-3 basis points (bps).

Borrowing costs in the region had previously been pulled down by a “safe haven” bid during Tuesday’s stock market turmoil.

This came after 10-year U.S. Treasury yields rose to a high of 2.87 percent overnight. US10YT=RR

Italian, Spanish and Portuguese government bonds slightly underperformed on the day, their yields rising 1-3 bps, having fallen sharply the previous day.

All three are still trading close to their tightest spreads with Germany in months, and in some cases years. Having a pro-European, pro-spending party at the heart of German government is seen as positive for these southern European countries.

Elsewhere, Greece launched its much-anticipated new bond on Thursday, drawing strong investor demand for the seven-year paper despite volatility on world markets.

Thursday also brought speeches by rate-setters from both sides of the Atlantic.

The U.S. Federal Reserve’s Patrick Harker said he expected a “small bump” to U.S GDP from the recent tax reform and that he did not think new chief Powell wants to make dramatic changes to the current policy path.

Fellow Fed policymaker Robert S. Kaplan had said previously that three rate increases this year remain the central bank’s base-case scenario regardless of the recent stock market rout.

Meanwhile, the European Central Bank’s chief economist, Peter Praet, said that a benchmark salary increase secured by Germany’s largest trade union this week was “fully in line” with the ECB’s inflation forecasts.

Bundesbank President Jens Weidmann had earlier said that the euro’s strength and the recent stock market rout do not justify any substantial extension of the European Central Bank’s bond purchase scheme.

The ECB’s Francois Villeroy de Galhau is also due to speak later on Thursday.

Reporting by Abhinav Ramnarayan, Additional Reporting by Fanny Potkin; Editing by Matthew Mpoke Bigg and David Goodman

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