Markets put money on ECB rate hike amid rising European bond yields

Traders boosted bets for a European Central Bank (ECB) rate hike this week, sending Italy's 10-year bond yield to a six-month high after a Reuters report that the central bank believes inflation will continue to hover around 3% next year.

The day's main macroeconomic event for global markets is US inflation data released at 1230 GMT which will help shape the Federal Reserve's rate decision later this month.

But there is plenty happening in Europe too, and traders are also bracing for the ECB's meeting on Thursday - current market pricing reflects roughly a 75% chance the central bank will raise rates by 25 basis points, up from around a 40% chance on Monday and just 25% a week ago.

A further rate hike this year is now fully priced in.

The rise in rate expectations on Wednesday was, said Jan von Gerich chief analyst at Nordea, a result of a Reuters report late on Tuesday which said, citing a source with direct knowledge of the matter, the ECB's quarterly projections will put inflation north of 3% in 2024.

That would support the case for a further rate increase, though the source said the rate decision was still a close call.

A pick up in market expectations also makes a rate hike more likely.

"The ECB isn't as sensitive to market expectations as say the Fed is, but it is not totally insensitive so this kind of pricing on the margin increases the odds of hiking," von Gerich said.

"It isn't conclusive, but they do look at market expectations and worry that if they disappoint too much then you could see rates fall, and financing conditions ease, which they don't want to at the moment."

The yield on Italy's 10-year bond hit 4.452% in early trading, its highest since mid-March, and was last at 4.44%, up 3 basis points (bps) on the day.

Germany's 10-year yield rose 2.5 bps at 2.67%, meaning that the spread between the German and Italian 10-year yields touched 178 bps, its widest since June.

Bond yields move inversely to prices and higher rates from the ECB would typically weigh more heavily on the more-indebted European periphery.

Some market participants expect an acceleration of the ECB's quantitative tightening measures – in which the central bank reduces its bond portfolio – to hurt peripheral bond prices.

Shorter-dated yields, more sensitive to interest rate expectations, also rose. Germany's two-year yield was up 3 bps at 3.16%, having briefly touched a one-month high, and Italy's two-year yield touched a two-month high and was last 7 bps higher at 3.9%.