Aug 14 (Reuters) - Euro zone government bond yields edged higher on Monday as U.S. economic data and a rise in natural gas prices last week highlighted the upside risks to the inflation outlook.
U.S. Treasury yields rose to one-week highs on Friday after producer price inflation in July was stronger than expected, a day after data showed consumer prices rose modestly.
Gas prices rose last week on concerns strikes could affect Australian liquefied natural gas (LNG) production, but retreated as the prospect of disruption appeared to ease.
U.S. natural gas futures hit their highest in over five months last week, while Dutch gas futures, widely used as the benchmark for the European market, gained nearly 30% in a day.
Germany's 10-year government bond yield, the euro area's benchmark, was flat at 2.62% after hitting a one-month high at 2.64%.
Analysts said that expectations for the rate outlook in the euro area are unchanged despite the rise in yields, with the U.S. Treasuries setting direction in the fixed-income market.
Money markets priced in a more than 50% chance of a European Central Bank rate hike by year-end, which would bring the depo rate to 4% and a rate cut by the first half of 2024.
December 2023 ECB euro short-term rate (ESTR) forwards were at 3.83%, implying expectations for a depo rate at around 3.93%, from the current 3.75%.
"These expectations (no rate hike in September but possible further rise by year-end) keep German yields rangebound, with the benchmark 10-year Bund yield around 2.5%," said Annalisa Piazza, rate strategist at MFS.
MFS’s Piazza does not expect the ECB to raise rates in September, but suggested further tightening moves were possible if inflation keeps rising.
Some analysts see euro area bonds as relatively insulated from a potential sell-off in U.S. Treasuries due to weak economic data.
German wholesale prices fell by 2.8% in July compared to the same time a year ago.
The German yield curve narrowed its inversion, with the gap between 2-year and 10-year yields at -40 bps, close to its highest level since the end of May.
An inverted curve, which is usually a reliable indicator of a future recession, means markets are pricing events that would trigger rate cuts by central banks.
Expectations that the ECB will keep rates high for longer to tame inflation are driving long-dated yields higher making German curves less inverted.
Investors will monitor short-dated German bonds as the Bundesbank said it would stop remunerating deposits for the German public sector from October.
"We expect a considerable amount of the remaining deposits to be switched into BuBills over time," said Christoph Rieger, head of rates and credit research at Commerzbank.
The German 1-year BuBill yield dropped 2.5 bps to 3.56%. It was around 3.64% on Aug. 4 before the Bundesbank decision. It hit its highest since 2008 at 3.785% on July 12. (Reporting by Stefano Rebaudo, editing by Barbara Lewis)
