Euro zone yields rise on inflation, bond supply concerns

By Stefano Rebaudo and Harry Robertson

LONDON (Reuters) - Euro zone borrowing costs edged higher on Monday as traders awaited key U.S. inflation data later in the week, amid fading hopes for a quick end to the central bank rate hiking cycle.

Analysts said potential upside surprises in consumer price data and expectations of increasing bond supply due to public spending to tackle the energy crisis would prop up German Bund yields in the medium term.

Germany will spend 83.3 billion euros, or 42% of a major protection scheme, to finance a cap on gas and power prices in 2023, a draft proposal seen by Reuters showed.

Meanwhile, German industrial production grew in September, supporting the view that the European Central Bank (ECB) will keep raising rates aggressively.

Yields on 10-year Bunds were last up 3 basis points (bps) at 2.319%, after moving in and out of positive territory earlier in the session. They hit an 11-year high at 2.53% on Oct. 21.

U.S. consumer prices data for October is due on Thursday, and will be closely watched for its implications for Federal Reserve policy.

"I don't think the market will do much ahead of U.S. inflation data," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

The year-on-year U.S. inflation rate is expected to have cooled to 8% in October from 8.2% in September, but traders will look out for any signs that core inflation - which strips out food and energy - remains strong.

"Markets expect a (Fed) rate hike of 50 bps in December and 25 bps early next year, but they are ready to change their view pretty quickly if consumer price numbers surprise on the upside," he added.

In Europe, investors grew optimistic that the ECB could soon start to slow down on rate hikes after its meeting last month, but the mood has since become more pessimistic.

Italy's 10-year government bond yield rose 1 bp to 4.469% on Monday. The spread between Italian and German 10-year yields fell 2 bps to 214 bps.

George Buckley, an economist at Nomura, highlighted in a research note that "numerous ECB Governing Council members came out saying there was much more to do on rates," after a "dovish interpretation of the October ECB meeting."

France's central bank chief Francois Villeroy de Galhau said the central bank must not stop raising interest rates until underlying inflation has peaked, but it may slow the pace of hikes once rates hit a level that starts to restrict growth.

We believe core European inflation "will strengthen, underscoring our view that the ECB will ultimately be forced to hike by yet another 75bp in December," Nomura's Buckley added.

(Reporting by Stefano Rebaudo and Harry Robertson, editing by Angus MacSwan and Toby Chopra)