European bonds have been torn apart by the ECB’s go-slow approach to inflation

Bond traders are punishing the European Central Bank’s focus on supporting growth amid record high inflation.

German 30-year bond yields rose to a three-year high, with markets unsatisfied as the central bank renewed its promise to complete bond purchases in the third quarter – a move to normalize monetary policy amid rising risks from rising prices.

Meanwhile, short-end interest rates — the most sensitive to monetary policy — fell, widening the pair’s gap the most since the coronavirus pandemic first struck two years ago.

Traders trimmed their bets on a July rate hike, seeing only a 50 percent chance of such a scenario after President Christine Lagarde stressed the threat to economic growth from Russia’s invasion of Ukraine.

They barely stirred even after reports that a consensus was forming among ECB Governing Council members for a quarter-point rate hike in the third quarter.

The ECB last raised borrowing costs in 2011, as inflation rose to a 2-1/2-year high amid a debt crisis that forced peripheral eurozone countries to seek bailouts from their peers. The move backfired, forcing the central bank to reverse course by year-end in a vain attempt to stave off a recession.

“Given the lessons of 2011, Lagarde seemed careful not to make a similar mistake and embark on a significant slowdown rather than tightening on an elevated inflation outlook,” said Piet Christiansen, chief strategist at Danske Bank A/S.

Money markets eliminated all bets on a 25 basis point rate cut within four years. This is in sharp contrast to betting on a quarter point of easing in two years by the Federal Reserve after pricing in 300 basis points of hikes.

This is a sign that traders expect the ECB to pull off a softer economic landing than its US counterpart from a tightening cycle.

“Regarding the Fed, which Lagarde also said the US economy is fundamentally different from the eurozone, they have a mission to slow economic activity, which points to aggressive tightening,” Christiansen said.