(Bloomberg) -- Euro-area bonds tumbled and traders bet the European Central Bank will raise interest rates to the highest level on record amid signs inflation in some of the region’s biggest economies is not coming under control.

The selloff was triggered after data Tuesday showed French and Spanish inflation unexpectedly accelerated in February, pushing two- and 10-year German yields to levels last seen more than a decade ago.

Money-markets traders briefly priced a 4% ECB terminal rate in the wake of the releases, which would exceed the peak in borrowing costs at the turn of the century. That compares to 3.5% expected earlier this year, with traders now betting the ECB will keep raising rates through February 2024. 

The European economy remains more resilient than expected despite a series of outsized hikes that have raised borrowing costs by 300 basis points since July. Focus now turns to euro-area inflation data due Thursday, where any signs that price pressures are broad-based and entrenched risk fueling bets on even more aggressive action.  

“Markets have not fully priced in the peak,” said Piet Christiansen, chief strategist at Danske Bank A/S. “It can push higher, in particular the May meeting pricing, which is still ‘only’ pricing a coin toss probability between 25 basis points and 50 basis points.”

 

That’s quite a turnaround from recent exuberance. Just three weeks ago, traders expected the central bank to stop raising rates by the middle of this year. 

The yield on two-year German bonds advanced to as high as 3.20% Tuesday, the highest since 2008, and nearly 80 basis points above a low reached in mid-January. The 10-year yield climbed as much as 13 basis points to 2.71%, the highest level since 2011.

Policy makers have been sounding the alarm, warning that the market is too complacent about the outlook and underestimating the bank’s resolve to bring inflation back to its 2% target. ECB Chief Economist Philip Lane said the central bank might hold borrowing costs at a high level for some time once they reach their peak, in comments published Tuesday.

“The question now therefore is whether more, or more aggressive, hikes are necessary,” said Tim Graf, head of macro strategy for EMEA at State Street Global Markets. “The terminal rate re-pricing in recent weeks may need to be adjusted even higher.”

Consumer prices in France jumped by a record 7.2% from a year ago, data released Tuesday showed. Spain’s headline inflation rose 6.1%, while a measure of underlying inflation that excludes energy and fresh food reached an all-time high of 7.7%. Traders have also revised up expectations of long-term inflation, with one gauge of market bets for price growth nearing its highest in more than a decade.

The repricing spread beyond euro-area markets, with 10-year Treasury yields approaching 4% — a level not seen since November. A string of stronger-than-expected US economic data has helped jolt traders out of the belief that the economy would cool down rapidly in response to rate rises.

The euro erased an earlier drop against the dollar, trading 0.3% higher at $1.0641 as of 3:27 p.m. in London.

“Investors perceive a very sticky inflation,” said Francesco Maria di Bella, a strategist at UniCredit Bank AG. “This would keep the ECB very hawkish.”

--With assistance from Alice Gledhill.

(Updates pricing, adds analyst comment in ninth paragraph. A previous version of this story corrected the date of the ECB’s rate hike.)

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