Euro zone bonds steady, spreads tighten as investors assess impact of Iran war
By Stefano Rebaudo
March 4 (Reuters) - Euro zone government bonds edged higher on Wednesday as investors paused after a sharp selloff earlier this week driven by fears the Middle East war would fuel inflation.
U.S. President Donald Trump had ordered the U.S. International Development Finance Corporation to provide political risk insurance and financial guarantees for maritime trade in the Gulf.
"A U.S. insurance for ships passing through the Strait of Hormuz could be a game changer, if successfully implemented," said Mohit Kumar, an economist at Jefferies, noting that if Gulf countries were to join the conflict it would signal an earlier end to the war.
Iran has already launched several strikes in the Gulf region.
"However, this would require a near-complete destruction of Iran's naval capabilities and/or pressure from its allies including China to let the ships pass," Jefferies' Kumar said, adding he sees the war continuing for at least a couple of weeks.
Germany's 10-year government bond yield DE10YT=RR, the euro area benchmark, fell 1.5 basis points to 2.76% after hitting 2.815% on Tuesday, its highest since February 11.
Italy's 10-year government bond yields IT10YT=RR fell to 3.40%. The gap versus Bunds tightened 7 bps to 67 after a 10-bp widening the day before. It was at 63 bps last Friday and it fell to 53.50 bps in mid-January, its lowest since August 2008.
The French gap DE10FR10=RR fell 1.5 bps to 60.5 bps.
An ECB tightening move would weigh on highly indebted countries, such as Italy, by raising their borrowing costs and limiting fiscal room.
Analysts added that with the ECB firmly on hold, stable funding costs favour carry trades, boosting demand for higher‑yielding bonds and tightening spreads. The backdrop would change if the ECB were expected to hike rates.
ECB HIKE CHANCES SEEN AT 30% IN 2026
The country's two-year yield DE2YT=RR, more sensitive to policy expectations, fell 4 bps to 2.14%.
Money markets increased bets on European Central Bank rate hikes but continued to price less than a 50% chance of such a move by year‑end. They indicated around a 30% probability of a tightening move in December EURESTECBM7X8=ICAP, from over 60% on Tuesday.
They also indicated a 35% chance of a hike by June 2027 EURESTECBM11X12=ICAP.
Data on Tuesday showed euro area consumer prices rose to 1.9% from 1.7% in February, beating forecasts for 1.7%.
"The inflation rate could climb in the direction of 2.5% in March, with a further upward trend," said Ulrike Kastens, senior economist at DWS.
"The speed of a correction in the energy markets will ultimately depend on the duration of the war," he said, adding that the ECB's assessment that it was in a good place remained valid in the short term.
The ECB should "sit tight" and keep interest rates steady for now as the impact of the war in Iran remains uncertain, ECB policymaker Martins Kazaks told Reuters on Tuesday.
