Euro area yields rise, Iran-Israel ceasefire and fiscal outlook in focus

By Stefano Rebaudo

June 25 (Reuters) - Euro zone government bond yields rose on Wednesday as investors processed concerns about increased fiscal spending across the euro area and kept a wary eye on the Iran-Israel ceasefire.

Germany's cabinet approved a draft budget with record investments on Tuesday, while on Wednesday, NATO leaders endorsed a higher defence spending goal of 5% of GDP by 2035.

German 10-year government bond yields DE10YT=RR, which serve as the benchmark for the wider euro zone, rose 3 basis points (bps) to 2.56%.

Yields on 30-year German bonds DE30YT=RR hit a near one month high of 3.087%.

Analysts expect rising bond supply across the euro area from more fiscal spending to drive long-term yields higher.

Though at least in the case of defense spending, the processes for raising funds, whether at a national or European wide level, remain uncertain.

"Market participants remain skeptical about Europe's ability to materially increase defence spending in the short term," said analysts at Goldman Sachs in a note.

Also in the mix were closely watched oil prices, which held near multi-week lows on the prospect that crude flows would not be disrupted, after a ceasefire between Iran and Israel.

Trump said that the intelligence following the strikes on Iranian nuclear sites was inconclusive, but also suggested the damage could have been severe.

Analysts argued that a spike in energy prices could lead to higher inflation and cause markets to scale back their bets on central bank rate cuts.

Analysts at Societe Generale said it could have pushed European headline inflation to 3.5% year on year, but the de-escalation had largely removed that risk.

"Now, the outlook moves back to the fundamentals that point to further disinflation, driven by softer energy prices, a stronger euro, and weakening wage pressures. Together, these factors should push headline inflation down to 1.5% year-on-year by end-2025," they said.

Money markets priced in a European Central Bank deposit facility rate at 1.75% in December EURESTECBM4X5=ICAP, a level seen before the Israeli attack against Iran on June 13, after a rise up to 1.80% on Monday.

A key market gauge of euro area long-term inflation expectations EUIL5YF5Y=R was last 2.12% from 2.08% on June 12.

A decline in risk appetite recently widened the yield spreads between government bonds of highly indebted countries and safe-haven German Bunds, before risk sentiment improved and spreads narrowed again.

The Italian yield gap versus Bunds DE10YT=RR, IT10YT=RR — a market gauge of the risk premium investors demand to hold Italian debt — was at 94 bps. It widened up to 104 bps last week, while being below 90 bps on June 12.

Italy's 10-year yields rose 2 bps to 3.51%.

The French gap versus Bunds FR10YT=RR, DE10YT=RR was at 69 bps after reaching 75 bps last week. It was at 65 bps in early June.