Oct 14 (Reuters) - Euro zone bond yields fell on Friday after a top European Central Bank policymaker flagged recession risks and investors grew wary of pricing in more aggressive monetary tightening.
The ECB is prepared for a possible technical recession paired with high inflation, which must be brought down to maintain market confidence, European Central Bank Vice-President Luis de Guindos said.
Investors will also focus on gilts after reports that Prime Minister Liz Truss's government was considering a U-turn on some of the measures in its late-September "mini-budget".
Prime Minister Truss and her finance minister Kwasi Kwarteng are "determined and resolute" to deliver their economic plans that have caused turmoil in the markets, junior trade minister Greg Hands said.
"Investors are waiting to understand what will happen in the UK as a rise in gilt volatility will spread to the euro area," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors. "Of course, de Guindos mentioning recession risks strengthens the view that the ECB will have to soften its stance."
Yields in British 10-year gilt were down 9 basis points (bps) at 4.1%.
Germany's 10-year government bond yield , the benchmark of the euro zone bloc, fell 9.5 bps to 2.21% after dropping 4.5 bps the day before. It hit its highest level since August 2011 at 2.423% on Wednesday.
"Euro area yields dropped late yesterday despite strong U.S. inflation data with investors not willing to bet on more monetary tightening," Allianz Global Investors' Maxia added.
U.S. consumer prices increased more than expected in September as rents surged by the most since 1990, but the numbers were not enough to push investors to price in more ECB monetary tightening and yields fell late on Thursday.
"The fact that inflation keeps outperforming consensus puts into question whether the neutral rate has risen compared to the post-Global Financial Crisis/pre-covid levels, higher than around 2.5%," Mizuho rate strategists said.
"But further inflation prints are needed before confirming this view with more conviction," they added.
Analysts have flagged some concerns about supply in government bond markets, with euro zone countries expected to increase public spending to fight the adverse impact of surging energy prices.
ECB policymakers discussed earlier this month a detailed timeline for running down a 3.3 trillion euro bond portfolio and envisioned the start of quantitative tightening sometime in the second quarter of 2023, sources told Reuters this week.
But Bank of America expects euro zone net government bond supply to rise close to a record high of 400 billion euros ($388 billion) next year.
Reporting by Stefano Rebaudo, Editing by Ana Nicolaci da Costa
Source: Reuters