Euro zone bond yields fall as market calms after ECB rout

But comments from ECB officials including Lagarde on Monday and Tuesday suggesting a big tightening of monetary policy is not needed and market reaction since the bank's policy meeting last week has been too strong appeared to provide some relief for markets.

Euro zone bonds calmed on Wednesday with yields set to fall for the first time in five sessions. With euro zone inflation stuck at record highs, markets last week seized on ECB President Christine Lagarde not repeating that a 2022 rate rise was very unlikely, sending bond yields and rate hike bets surging.

But comments from ECB officials including Lagarde on Monday and Tuesday suggesting a big tightening of monetary policy is not needed and market reaction since the bank's policy meeting last week has been too strong appeared to provide some relief for markets. 

While yields still ended the day higher on Tuesday, driven in part by a rise in U.S. Treasury yields, on Wednesday, Germany's 10-year yield, the benchmark for the bloc, was down 4 basis points to 0.23% by 1223 GMT.

Germany's five-year yield, which rose above 0% for the first time since 2018 on Friday was down 5 bps to -0.03%. 

Italian and Greek bonds, the biggest beneficiaries of ECB stimulus, which had underperformed since the ECB meeting, also rallied. Bond yields move inversely to prices.

The yield on Greece's 10-year benchmark bond was down around 4 bps on the day according to Tradeweb and MarketAxess quotes. Italy's 10-year yield was also 4 bps lower at 1.81%. 

"I think to some extent the comments from (the ECB's Francois) Villeroy and Lagarde... they're doing a bit of backtracking when things have gone too crazy. 

That's been the main thing behind this (rally)" said Jens Peter Sorensen, chief analyst at Danske Bank.

"It's been pretty massive how much yields have risen. Even though (the ECB) have shifted, they got a lot more than what they had expected on the back of a meeting." 

The closely-watched Italian yield spread with German 10-year bonds, effectively the risk premium on Italian debt, was down a touch to 157 bps.

Wednesday's calm appeared to be tentative, however. The drop in yields is small compared to the recent surge - Italian 10-year yields are up some 40 bps since the start of last week, for example.

Money market bets still imply around an 80% chance of a 10 bps ECB rate hike by June and a 90% chance of 50 bps of hikes by December, similar to Tuesday's levels.

The German central bank's new head said the ECB could raise interest rates this year, while ECB board member Isabel Schnabel will give a speech later in the session. 

The primary market is also busy, with Spain receiving 60 billion euros of demand for a new 30-year bond in the euro zone's first major government bond sale since the ECB's hawkish turn.

Germany re-opened a 30-year bond and raised 1.266 billion euros, slightly below the 1.5 billion euro target. 

Portugal re-opened bonds due in 2028 and 2031 to raise 1.25 billion euros at much higher yields compared to previous auctions.