Euro-Area Bonds Rally With ECB Rate-Hike Bets for 2022 on Ice

(Bloomberg) -- Government bond surged across Europe on Tuesday as rates traders bet the European Central Bank will put off raising interest rates until March next year given the risk that Russia's invasion of Ukraine poses to the growth outlook.

The repricing comes as investors come to terms with the fallout and assess the prospect of a longer period of exceptionally accomodative monetary policy. Governing Council member Olli Rehn said the central bank shouldn't exit stimulus measures before gauging the impact of the war, compounding the move.

The yield on 10-year Italian debt -- among the most sensitive to prospect of looser policy -- fell as much as 33 basis points to 1.37%, erasing the advance which followed the ECB's hawkish pivot early last month. German 10-year yields slid as much 19 basis points to minus 0.06%, on course for the largest daily decrease since 2011.

Money market traders are now betting the ECB will deliver its first quarter-point increase in March 2023. As recently as the middle of last month, they were wagering on two such increases in September and December, bringing the deposit rate to zero for the first time since 2014.

“We're seeing a textbook flight to quality move in bond yields, combined with a reassessment of the ECB's tightening odds this year,” said Antoine Bouvet, senior rates strategist at ING Bank NV.

Investors have been preparing for policy makers to start winding down stimulus in the face of record inflation, a task now complicated by the economic impacts of war and sanctions. The price of oil and gas surged to multi-year highs amid the turmoil, potentially curbing consumption.

The paring back of tightening bets follows recent dovish comments from ECB policy makers. ECB's Robert Holzmann last week said the Ukraine conflict may delay the central bank's exit from stimulus measures, while his colleagues Mario Centeno and Fabio Panetta recently urged patience and caution in adjusting policy.

Sour risk sentiment is “driving the front end lower,” said Piet Christiansen, chief strategist at Danske Bank. The “current repricing makes sense” and is more in line with what he believes the ECB and President Christine Lagarde are “comfortable with,” he said.

Last month, Goldman Sachs Group Inc. and Deutsche Bank AG forecast two 25-basis-point rate hikes this year. Strategists at Goldman Sachs are sticking to that call and recommend fading any delay in ECB tightening wagers given the significant upside shock to near-term inflation.

Still, the ECB could find the conflict to “be potentially damaging to the Eurozone economy,” said Viraj Patel, global macro strategist at Vanda Research in an interview on Bloomberg Television. “Being dovish on the ECB -- playing that wait-and-see game around rate hikes -- for us makes much sense.”