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The focal point in the European bond market at the moment is the political situation in Italy, explained analysts at Danske Bank. They continue to see higher 10-year yields as a 2019 history.

Key Quotes:

“Since the beginning of May Italian 10-year yields have widened more than 140bp, and the spread to Germany is now above 260bp while the outright 10-year yield has been above 3% in Italy. We have to go back to 2013-14 to see similar levels for Italian yields and spreads. There is a genuine risk that a new debt crisis is on the way in Italy and the impact on the financial markets outside Italy has been sizeable.”

“Investors have sought shelter or safe-haven in the German government bond market and 10-year German Bund yields have been more or less halved in a week to currently 0.35%.”

“Sentiment indicators, including PMI, ifoand ZEW have pointed towards abating growth momentum in the eurozone. Although we expect the euro area business cycle to move one gear lower, we still look for robust growth of 2.1% in 2018 and 1.9% in 2019.”

“We expect the first ECB hike of 20bp only in December 2019, due to increased downside risks to the growth and inflation outlook.”

“We do not expect the ECB to shift towards more optimistic language with regard to the inflation outlook anytime soon.”

“Political risks have risen recently and are likely to stay elevated amid the Italian turmoil but, so far, we do not expect this to affect the ECB’s monetary policy stance.”

We continue to expect a steeper EUR yield curve on a 12M horizon. The ECB still maintains a relatively tight grip on the short end of the curve. However, this is not the case for the 10Y segment of the curve, which we expect to be pushed by higher US yields, the end of ECB QE from the ECB and the pricing of rate hikes in 2020. An
expected higher term premium works in the same direction. We have a 12-month 1.1% forecast for 10Y Germany. Higher 10Y yields is mainly a 2019 story.”