Euro zone bond yields fall for second day, central bank meetings in focus

By Samuel Indyk

LONDON, March 17 (Reuters) - Euro zone government bond yields edged lower on Tuesday as markets paused ahead of a slew of central bank decisions later this week, even as oil prices rose again.

Brent crude LCOc1 climbed about 2.3% as traffic through the Strait of Hormuz remained severely disrupted, fuelling concerns about higher energy costs and inflation.

The Federal Reserve delivers its policy decision on Wednesday, followed on Thursday by the Swiss National Bank, the European Central Bank, the Bank of England and the Bank of Japan.

"Markets are bracing themselves for the central bank avalanche kicking off tomorrow," said Commerzbank rates strategist Erik Liem in a note.

Expectations for near-term rate cuts from the Fed and BoE have been dashed by the jump in energy prices since the start of the U.S.-Israeli war with Iran, while markets have moved to price in tighter ECB policy by year-end.

The hawkish global repricing has pushed up euro zone bond yields to their highest in months, with the bloc's economy particularly sensitive to rising energy costs, although yields have eased slightly this week.

"The decline in yields that we've seen for a couple of days is a pullback after the massive selloff (in bonds)," said Jussi Hiljanen, rates strategist at SEB. Bond yields move inversely to prices.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone, was down 3 basis points at 2.919% but still close to Friday's peak of 2.994%, its highest since October 2023.

The two-year yield DE2YT=RR, which is more sensitive to ECB rate expectations, was down 1.6 bps at 2.394%. It has risen more than 40 bps since the outbreak of the conflict on February 28.

Money market traders are pricing in about 38 bps of ECB tightening by year-end, implying one quarter-point rate hike and about a 50% chance of a second.

SEB's Hiljanen said markets may need to price in more tightening as he sees no quick resolution in the Middle East.

"The scenario that we have been pencilling in is that if this continues for a couple of months with elevated energy prices, markets should move to price two to three ECB rate hikes this year," he said.

Italy's 10-year yield IT10YT=RR, the benchmark for the euro zone's more indebted countries, was down 4.6 bps at 3.684%, narrowing the gap over Germany DE10IT10=RR to 75.5 bps.