Euro zone yields jump as Italy and UK keep traders nervous

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LONDON (Reuters) -Euro zone government bond yields rose to new multi-year highs on Tuesday as investors positioned for more interest rate rises and the impact from Britain’s “mini budget” continued to reverberate around financial markets.

U.S. Treasuries provided further upside pressure, with the 10-year yield hitting a fresh 12-year high at 3.97%.

Germany’s 10-year yield was at a new nearly 11-year high of 2.228%, up 14 bps..

Italian yields rose more markedly with the 10-year yield hitting its highest since June 2013 at 4.75%, following big moves on Monday after a rightist coalition won a clear majority in Sunday’s election.

Giorgia Meloni looks set to become Italy’s first female prime minister at the head of its most right-wing government since World War Two, inheriting one of the euro zone’s biggest debt burdens at a time of rising interest rates and slowing economic growth.

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“Policy uncertainty will continue to be the key driver here. In the coming days, we expect other parties’ leaders to back Meloni. This should deliver the appearance of calm (ie. spreads not blowing out disproportionally) before the ‘2023-budget-discussion-storm’, which is likely to develop throughout October,” Mizuho analysts said.

The closely watched spread between Italian and German yields widened to as high as 265 basis points in initial trading before falling to 250 bps by 1521 GMT, still around the highest since July.

Markets will be watching closely for the ECB’s take on the rise in Italian yields. On Monday ECB President Christine Lagarde said the bank would not use its latest emergency scheme to buy the bonds of countries that make “policy errors”, in response to a question about Italy’s likely next government.

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ECB SPEAKERS

Mario Centeno, seen as an ECB dove, said inflation would be higher and less transitory than originally thought and a cycle of rate hikes would continue to try to tame it.

Euro zone banks are set for some pain as the economy slows and higher interest rates land some companies in hot water, ECB’s vice-president Luis de Guindos said.

U.S. Federal Reserve officials on Monday sounded another hawkish note, saying their priority remained controlling domestic inflation, even with elevated volatility.

Investors were also in a nervous mood after the selloff in British government bonds sparked by a series of tax cuts the government announced Friday that would be paid for by more public borrowing. The prospect of tens of billions of pound more in borrowing rattled markets and sent sterling to record lows.

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The Bank of England is likely to deliver a “significant policy response” to last week’s announcement of tax cuts, BoE Chief Economist Huw Pill said on Tuesday.

Expectations for interest rate rises have soared in recent days.

“We see a reasonable chance that investors will regard those peak levels as toppish and that there is little incentive to price in even higher expectations at this stage. Growth worries appear to have been completely ignored in recent days,” the UniCredit analysts said.

(Reporting by Tommy Reggiori Wilkes; Additional reporting by Stefano Rebaudo; Editing by Jason Neely and Alison Williams)

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