Euro zone yields at multi-year highs, German real yield briefly positive

(Reuters) - Euro zone short-dated borrowing costs fell on Wednesday tracking moves in UK gilts, but were not far off their multi-year highs amid monetary tightening expectations and concerns about potentially growing bond supply due to more public spending.

Euro area bond yields have recently trailed UK gilts yields which made their sharpest rise in decades in response to new finance minister Kwasi Kwarteng's tax cuts and borrowing plans.

British government prices soared after the Bank of England announced it would intervene in the 2.1 trillion-pound gilt market that was starting to seize up.

Germany's 10-year government bond yield, the benchmark of the bloc, rose 2.5 basis points (bps) to 2.28% after hitting a fresh nearly 11-year high at 2.35%.

The 2-year yield dropped 6 bps to 1.926%. It hit its highest since December 2008 at 2.03% on Monday.

German yield curve steepened after being close to inversion last week, with the gap between 2- and 10-year yields hitting at an almost 3-week high of 42.7 bps.

European Central Bank officials said the ECB may need to raise interest rates by another 75 bps at its October meeting and move again in December to a level that no longer stimulates the economy.

Investors also fear that a further expansion of budget deficits to support the economy might hurt bond prices.

The 10-year inflation-linked yield was flat at -0.03%, after rising to positive territory for the first time since June 2015 at 0.04%.

"Rising yields in part reflect the unwinding over the last month of expectations for an early pivot in central bank, and particularly Federal Reserve, policy," said Mark Haefele, Chief Investment Officer, UBS Global Wealth Management.

"But we think the rise in longer-term yields may not accurately reflect the risks facing the economy," he added.

The jump of yields on UK gilts also widened yield spreads between core and peripheral government bonds.

Graphic: gilt&spread

Italy's 10-year bond yield was up 3 bps to 4.79%, after hitting its highest since February 2013 at 4.927%, with the spread between Italian and German 10-year yields at 252 bps.

Investors focused on Italy's budget after the centre-right coalition led by Giorgia Meloni won a clear majority in Sunday's elections, inheriting one of the euro zone's biggest debt burdens at a time of rising rates and slowing economic growth.

Mario Draghi's outgoing government will unveil new growth and public finance estimates this week in its Economic and Financial Document (DEF), which will form the framework for the 2023 budget to be examined by European Union.

"We have a target at 250 bps for the 10Y Italian-German yield spread, but with risks skewed on the upside, as the backdrop is not favourable for peripheral bonds," said Francesco Maria Di Bella rate strategist at UniCredit.

"Italian elections didn't affect the market much. The real issues now are gas prices which might push inflation higher, and a possible quantitative tightening from the ECB, which would hurt the most indebted countries," he added.

Dutch and British gas prices mostly rose on Wednesday amid concerns that Russia could stop gas supply to Europe via Ukraine over a payment dispute.

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

By Stefano Rebaudo