By Stefano Rebaudo
June 21 (Reuters) - Euro zone short-dated yields hit fresh highs and market bets on policy rates rose to 4% on Wednesday, as data from Britain was a stark reminder that the fight against inflation is not over and central banks might need to tighten further.
British inflation was unchanged at 8.7% in May compared to April's data, contrary to expectations for a slight fall.
Investors on Wednesday ramped up bets on the Bank of England raising interest rates by a half a percentage point on Thursday.
"Being specific to the UK economy – and reflecting the tightness of the labor market – are the strong wage growth numbers," said Gero Jung, chief economist at Mirabaud AM.
"Between February and April, average earnings grew at a near record pace of 7.2% (annualised) – signalling that there are likely strong effects from a wage-price spiral," he added.
Euro area short-dated yields are climbing towards levels seen before fears of a banking crisis disrupted financial markets in March, which sent market bets on where policy rates would peak to around 3%.
Germany's 2-year bond yield, the most sensitive to expectations for policy rates, rose on Wednesday 3.5 bps to 3.19%, after hitting 3.235%, its highest since March 10. It hit its highest level since October 2008 at 3.385% on March 9.
December 2023 forwards on European Central Bank (ECB) euro short-term rate (ESTR) were at 3.9%, implying market expectations for an ECB depo rate at 4% by year-end.
Analysts pointed to comments from Bank of France Governor Francois Villeroy de Galhau on Tuesday, who said the ECB has completed most of its interest rate increases, and any further hikes would be less critical than the duration of tight monetary policy.
Germany's 10-year bond yield, the benchmark of the euro area, rose 2 bps to 2.42%.
Lithuanian policymaker Gediminas Simkus also said on Tuesday that a rate hike in September wouldn't be a surprise. Markets have been pricing this in since the ECB policy meeting last week.
Following the selloff on the UK inflation data, markets will be waiting for Federal Reserve Chair Jerome Powell to deliver semi-annual monetary policy testimony to the U.S. House Financial Affairs Committee at 1400 GMT.
"The economy faces multiple challenges, including inflation, banking-sector stress, and geopolitical instability. The Federal Reserve must remain attentive to them all," Fed governor and vice chair nominee Philip Jefferson said in testimony prepared for his confirmation hearing on Wednesday.
"Inflation has started to abate, and I remain focused on returning it to our 2% target," he added.
Italy's 10-year bond yield, the benchmark of the periphery, rose 3 bps to 4.06%, with the spread between Italian and German 10-year yields at 162 bps after hitting last week its tightest level since April 1 below 150 bps. (Reporting by Stefano Rebaudo, editing by Emma Rumney)