Euro area bond yields fall with oil prices, central banks in focus

By Stefano Rebaudo and Harry Robertson

March 16 (Reuters) - Bund yields fell on Monday from their highest in almost 2-1/2 years as the Trump administration focused on getting oil through the Strait of Hormuz, although traders continued to bet on inflation shock forcing central bankers to raise rates.

Oil prices are up more than 40% this month as Iran has halted shipments through the strait in retaliation for U.S. and Israeli air strikes.

However, they fell slightly on Monday as U.S. President Donald Trump increased pressure on allies to help oil through the strait and as Treasury Secretary Scott Bessent said the administration is "fine" with some Iranian, Indian and Chinese ships going through the passage.

Yields on Germany’s 10-year government bond DE10YT=RR, the euro zone benchmark, fell 4 basis points (bps) to 2.933%. On Friday they touched 2.994%, the highest level since October 2023.

Italy’s 10-year government bond yield IT10YT=RR fell 9 bps to 3.701%.

Money markets are fully pricing one European Central Bank rate hike by July EURESTECBM4X5=ICAP, along with a roughly 80% chance of a second increase by year-end. EURESTECBM7X8=ICAP

The market is anticipating a proactive, zero-tolerance ECB that is willing to sacrifice growth in order to defend its inflation credibility, but most economists believe that the Governing Council will not support a near‑term rate hike.

“The euro area is facing a new inflation shock, but that is still likely to be temporary and modest," Berenberg chief economist Holger Schmieding said.

"It’s a political bet, namely that Donald Trump has no interest in high petrol prices for American consumers for a long time and he will look for a way out,” he added.

BUSY WEEK FOR CENTRAL BANKS

The Federal Reserve will announce its policy decision on Wednesday, with the European Central Bank, the Bank of England and the Bank of Japan following a day later.

Central banks are expected to hold interest rates this month, but investors will focus on any clues as to how policymakers might respond to the economic impact of the conflict in the Middle East.

Citi reiterated this morning that a couple of ECB “insurance” hikes can’t be fully ruled out, even though its base case remains that uncertainty justifies the central bank inaction.

Germany’s 2-year yield DE2YT=RR, more sensitive to expectations for policy rates, was 3 bps lower on Monday at 2.4%, having hit 2.476% last week, the highest since August 2024.

Although German bonds have lost some of their safe-haven appeal, spreads widened when war developments hurt risk appetite.

The 10-year yield spread between Italian government bonds and Bunds DE10IT10=RR was at 76.5 bps, widening from 63 bps before the U.S. and Israel launched the war on Iran. The spread had narrowed to 53.50 in mid-January, its smallest since August 2008.

The prospect of policy rate hikes has halted the tightening of euro area yield spreads, as it could bring fiscal concerns back into focus.

However, with 5-year inflation swaps still close to 2%, there are no market signs of inflation expectations becoming unanchored, ING argued in a research note.

The market gauge of euro zone medium-term inflation expectations EUIL5YF5Y=R was at 2.2%, its highest level since March 2025.

French 10-year bonds were yielding 66.5 bps more than Bunds DE10FR10=RR, compared with 58 bps before the conflict began.