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Euro area benchmark Bund yields hit their highest level in almost 2-1/2 years on Thursday, as conflict in the Middle East fuelled inflation fears and expectations for interest rate increases. Oil prices jumped on fears that the conflict and related oil-flow disruptionsthrough the Strait of Hormuzwould continue for an extended period.
Germany’s 10-year government bond yield was up one basis point (bp) at 2.94%, after hitting 2.963%, its highest since October 2023.
Money markets were fully pricing a European Central Bank rate hike by July, and a 70% chance of a second increase by December.
In late February, before the outbreak of the war, traders had attached a roughly 40% chance to a rate cut from the ECB before year-end.
Economists are inclined to rule out any move at next week's policy meeting, arguing that the Strait of Hormuz would need to be closed for several months to prompt ECB monetary tightening.
However, Wednesday's comments from policymakers fuelled expectations of further tightening. ECB board member Isabel Schnabel said the post-pandemic spike in inflation had left scars on companies and consumers, who now knew that prices could rise fast and settle at a higher level, after policymakers promised swift action if they thought higher inflation might become entrenched.
Hauke Siemssen, rate strategist at Commerzbank, said: "We stick to our assessment that the ECB will end up not raising rates this year ...
"However, markets seem likely to price adverse scenarios for the time being as the hawkish talk continues to keep inflation expectations in check," he added.
Italy’s 10-year government bond yields rose 5.5 bps to 3.70%. Although German bonds lost some of their safe-haven appeal, spreads edged wider when war developments hurt risk appetite.
The yield gap between Italian government bonds and Bunds widened to 73 bps. It had been at 63 bps before the attack on Iran and hit 53.50 in mid-January, its lowest level since August 2008.
(Reporting by Stefano Rebaudo; Editing by Amanda Cooper and Kevin Liffey)
