German bond yields at multi-year highs after Schnabel, ahead of Fed

By Stefano Rebaudo

(Reuters) - German 10-year government bond yields remained around multi-year highs on Wednesday ahead of a U.S. Federal Reserve policy meeting, and after the European Central Bank's Isabel Schnabel said a rate increase in July was possible.

The Fed is expected to raise interest rates by half of a percentage point and announce the start of reductions to its $9 trillion balance sheet.

The ECB need to raise interest rates as soon as July to stop inflation from getting entrenched, ECB board member Schnabel told German newspaper Handelsblatt.

"Fundamentally, it's the Isabel Schnabel interview (affecting bond yields). To some extent, she represents the majority view on the Governing Council," Chris Scicluna, head of economic research at Daiwa Capital Markets, said.

Last month ECB dove Luis de Guindos said the central bank should end its stimulus programme in July and could raise interest rates that same month.

Germany's 10-year government bond yield, the benchmark for the euro zone, was up 3 basis points (bps) at 0.985%, after hitting its highest since June 2015 at 1.036% earlier on Wednesday.

It climbed above 1% for the first time since June 2015 on Tuesday, increasing as much as 4 bps before closing flat.

Citi analysts said: "If the Fed delivers 'just' +50 bp, and the BoE a dovish 25 bp tomorrow, this could be the catalyst for a tentative relief rally given the starting point is 250 bp priced for the six meetings remaining this year."

Money markets are currently pricing in 260 bps of Fed rate rises this year, including 50 bps on Wednesday, and a 66% chance of a 50 bps rate increase from the Bank of England on Thursday.

The table below shows money market expectations about Fed rate hikes.

"Treasuries should remain largely unimpressed (by a 50 bps Fed rate hike), and the market will be more focused on guidance regarding the further hike path, with a total of 250 bp priced in until year-end," Commerzbank analysts said.

Money markets are pricing in 93 bps of European Central Bank rate increases by year-end, up from around 90 bps on Tuesday.

"In our view, the only question is how fast will the Fed move to a $95 bln roll-off per month," ING analysts said.

Italy's 10-year government bond rose 8 bps to 2.95%, its highest since March 2020, with the spread between German and Italian 10-year yields rising to 192.5, its widest since June 2020.

Spreads between core and peripheral bond yields have widened recently after hopes for more fiscal and monetary stimulus were disappointed last month.

(Reporting by Stefano Rebaudo, additional reporting by Dhara Ranasinghe; Editing by Alex Richardson)