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Euro Zone Yields Choppy as Markets Assess SVB Collapse on Rate Outlook

LONDON, March 14 (Reuters) - Short-end euro area yields rose on Tuesday, following sharp drops the previous day as investors weighed the impact of Silicon Valley Bank's (SVB) collapse on the outlook for European Central Bank policy.

Germany's 2-year yield was down by as much 27 basis points (bps) to 2.425% in early trade, its lowest since Jan. 19. It later pared those price gains, leaving the yield up 3 bps at 2.733%.

The 2-year yield, which is highly sensitive to ECB interest rate expectations, stood above 3.3% last week.

The SVB collapse triggered a mammoth rally in global bond markets on Monday, which saw the biggest one-day decline in the 2-year Treasury yield since 1987, at 56 bps. Yields move inversely to prices.

On Sunday, U.S. regulators took measures to stem the consequences of the bank's collapse and shore up confidence in the banking system, but markets are assuming interest rates will increase less than previously thought.

Ahead of the ECB's meeting on Thursday, markets are fully pricing in a 25 basis point hike and around a 50% chance of a larger half-point move. They had priced in a 50 basis point hike with near certainty last week.

The ECB terminal rate is expected to be around 3.3% in October this year, from above 4% previously.

"While the Fed might become more dovish in the short term, we don't believe this will happen with the ECB, at least during this week's policy meeting," Massimiliano Maxia, a senior fixed-income specialist at Allianz Global Investors, said.

"We didn't change our forecasts, and we expect the ECB to raise rates by 50 bps on Thursday and be data-dependent from then on."

A market gauge of long-term inflation expectations in the euro zone fell to 2.3514%, close to its lowest level since Feb. 9. It reached 2.6083% on March 6.

Markets have also lowered tightening expectations for the Federal Reserve, with futures pricing in policy easing as early as July.

Nomura analysts even forecast the Fed will cut rates at next week's meeting as policymakers assess financial stability risks. Previously, they expected the Fed to raise rates by 50 basis points.

Michael Leister, head of interest rates strategy at Commerzbank, said central banks were in a predicament.

"While still keen to stay on the path towards higher rates, the (unknown) second order of effects of the massive policy tightening since last year are now taking over," he said.

Germany's 10-year yield , the euro area benchmark, was last up 2 basis points to 2.303%, having hit a 5-week low of 2.168% on Monday.

Italy's 10-year yield rose 2 basis points to 4.238%.

The closely watched spread between German and Italian 10-year yields earlier widened to around 197.5 basis points, its widest level since Feb. 2.

The index of bond market volatility hit its highest level in 14 years on Monday.

With volatility spiking, analysts said Tuesday's U.S. consumer prices data is likely to have less impact than expected last week.

"In case of another nasty upward surprise, the market response might be more muted than it would otherwise have been," UniCredit analysts said in a note.

"In contrast, a miss of consensus expectations on the soft side might add to the recent bull run in bonds," they added.

Reporting by Samuel Indyk; Editing by Amanda Cooper and Barbara Lewis

Source: Reuters

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