Europe’s Bond Market Gets Wake-Up Call from ECB Warning

European bond investors are coming to terms with the fact that this year’s deep losses may run into 2023. After suffering a torrid year, European bonds are enduring a ruthless sell-off, the worst in months, after the eurozone’s central bankers warned investors that interest rates are expected to continue to rise. 

With analysts already warning of another 130-basis-point hike, much higher than the 50-basis-point hike expected from the US Federal Reserve, a fresh round of selling is inevitable.

Bonds have an inverse relationship to interest rates. When interest rates rise, bond prices usually fall. With high interest rates, investors no longer prefer the lower fixed-interest rate paid by a bond, resulting in a decline in its price and a sell-off.

In recent days, European Central Bank (ECB) policymakers have demonstrated a newly found resoluteness to reduce double-digit inflation, after having been late to the inflation-busting party. That’s bad news for bond investors who had bet big on the EU’s bond assets with a false sense of confidence, given early signs inflation was peaking.

European bond markets have been quick to respond to ECB warnings. Since last week’s ECB meeting, investors have adjusted their expectations and expect a higher interest rate peak rate at 3.3%. 

It is a blow for the managers of the region’s government debt, marking what is likely to be the worst year on record. Informed estimates on the performance of the sector place this year’s losses at 15.5%, by far the biggest annual fall on record.