Two-year euro zone bond yields set for weekly decline in tense trade

By Amanda Cooper

LONDON, April 17 (Reuters) - Short-dated euro zone government bond yields edged up on Friday, but were still set for a third straight week of declines, as investors grew increasingly optimistic that the Iran war and subsequent energy shock may soon be over.

U.S. President Donald Trump expressed confidence that a deal could soon be reached to end the conflict. He said the next meeting between the United States and Iran could take place at the weekend and an extension of a two-week ceasefire was possible.

Denting bond prices on Friday, which drove up yields, has been the strength in oil prices this week, which are on track for a 3% gain. The effective closure of the Strait of Hormuz, now under a U.S. blockade, has wiped out much of the available crude in physical markets outside the Gulf.

Two-year German Schatz yields DE2YT=RR, which are more sensitive to expectations for near-term rate decisions and inflation than benchmark 10-year debt, were up 1.4 basis points in early trading at 2.547%.

They are heading for a weekly decline of 6 bps but that would still be around 50 bps higher than they were before the war.

Money markets show traders now only see a 15% chance of the European Central Bank raising interest rates at its April meeting 0#EURIRPR, down from closer to 80% at one point in recent weeks, although the prospect of two rate hikes in 2026 remains comfortably priced in.

ECB officials, including President Christine Lagarde, were out in force this week, talking down the possibility of a string of rate hikes, which helped temper some of those market-based expectations.

"With the June meeting still seven weeks away, a lot can happen. However, without a renewed crisis escalation that pushes oil prices sustainably above $100, we see better chances that the ECB will hike by less than forwards predict," Commerzbank rate strategist Christoph Rieger said.

German 10-year yields DE10YT=RR, which serve as the benchmark for the broader euro zone, were up 1.5 bps at 3.048%. They remained unchanged on the week and 40 bps above where they were in late February when the war started.

Elsewhere, Italian two-year yields IT2YT=RR headed for a third weekly decline, but were up 3 bps on the day at 3.835%.

Two-year BTP yields have risen more than most other developed market bonds since the start of the war, surging 65 bps given Italy's already fragile government finances and a hefty energy import bill.

Ten-year BTP yields IT01YT=RR climbed 1.1 bps to 3.819% , bringing their premium over Bunds DE10IT10=RR to 77 bps. This spread, which many investors view as a barometer of global risk appetite, reached a nine-month high above 100 bps in late March.