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Eurozone stocks rise and bonds fall as traders assess policy direction

European stocks extended their gains on Monday, while government bonds in the region were hit by a fresh bout of selling as traders assessed how far inflationary pressures would push the bloc’s central bank to tighten monetary policy.

The regional Stoxx Europe 600 share gauge and Germany’s Dax index finished the day up 0.6 and 0.8 per cent, respectively. Those moves followed upticks in Asian markets, with Hong Kong’s Hang Seng index and Japan’s Topix rising 2.1 and 1.9 per cent, respectively.

The FTSE All-World index rose 0.7 per cent, having snapped a seven-week losing streak on Friday. This was driven by the best performance for Wall Street’s benchmark S&P 500 since November 2020 after softening economic data encouraged investors that the Federal Reserve could slow its tightening of monetary policy. US markets were closed on Monday for a holiday.

Monday’s equity moves also came as Chinese authorities signalled the easing of some pandemic restrictions on business activity in Shanghai, with European consumer businesses making some of the largest gains. European luxury goods companies were among the stocks to climb, with LVMH up 2.6 per cent and Gucci owner Kering up 3.3 per cent.

In government bond markets, Germany’s 10-year Bund yield rose 0.09 percentage points to 1.06 per cent as its price fell. The pressure on the debt instrument, viewed as a proxy for eurozone borrowing costs, came as the preliminary German inflation reading for May came in at 8.7 per cent year on year, higher than analysts’ consensus expectations of 8 per cent.

Line chart of 10-year government bond yield (%) showing High-grade eurozone debt under selling pressure

“Inflation in the eurozone’s largest economy is still taking no prisoners,” Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, wrote in a note. “The pressure on the ECB over the summer is only going one way: up.”

Economists polled by Reuters expect consumer price growth for the broader eurozone area to have reached a new high of 7.7 per cent when data are released on Tuesday.

Yields for French and Italian 10-year bonds on Monday rose by 0.08 and 0.1 percentage points, respectively.

Bonds were hit by selling even though Philip Lane, chief economist of the European Central Bank, said that gradual quarter-percentage point interest rate rises in July and September would be its “benchmark pace”. He told Spanish business newspaper Cinco Días that “what we see today is that it is appropriate to move out of negative rates by the end of the third quarter, and that the process should be gradual”.

The ECB’s current deposit rate sits at minus 0.5 per cent.

Paul Flood, a multi-asset portfolio manager at Newton Investment Management, said: “The economy remaining strong might result in a further sell-off in bonds. We think we’ll get a peak in inflation [towards the end of the year], allowing a little more space [to central banks] going forward.”

Central banks have engaged in the most widespread tightening of monetary policy for more than two decades, according to Financial Times analysis, in an effort to tame inflation provoked by the war in Ukraine, tightened global supply chains and a rebound in demand.

Investors will also look for signs of cooling in the US jobs market when the country reports unemployment data on Friday. A hot labour market has been a driver of climbing prices in the world’s biggest economy.

The US dollar, which is typically perceived as a haven asset and is up almost 6 per cent this year in comparison with peer currencies, was on course for a monthly fall in May. The US dollar index, which measures the greenback against a basket of six currencies, was down 0.3 per cent on Monday.

In commodities, international oil benchmark Brent crude rose higher than $120 a barrel for the first time since March as EU members continued to debate an embargo on Russian supplies.

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