Germany's benchmark 10-year government bond yield has risen, with recent reports indicating it climbed to 3.15% and even touched 3.20% in mid-May, marking its highest level since May 2011. Another report stated it hit 3.146%, the highest since 2011. This surge is largely attributed to a significant increase in oil prices, with Brent crude jumping 3% to above $90 a barrel due to escalating hostilities between the United States and Iran, which disrupted oil shipments through the Strait of Hormuz. The upward movement in oil prices has intensified concerns about inflation in the eurozone and strengthened expectations that the European Central Bank (ECB) will maintain a hawkish stance on monetary policy.
Money markets are reflecting these concerns, pricing in a deposit rate of 2.69% by December and 2.77% by February 2027, up from the current rate of 2.25%. Traders have also fully priced in a rate hike at the ECB's September policy meeting. Despite these expectations, investors broadly anticipate the ECB to keep interest rates unchanged at its upcoming policy meeting later this week, opting to assess the full impact of the Middle East conflict on inflation and economic growth before making further moves.
The spread between Italian and German 10-year bond yields has widened to 82 basis points, the highest since early May, reflecting increased apprehension over geopolitical risks and their potential effects on sovereign debt markets. This spread had narrowed to 63 basis points in February but expanded significantly to 103.62 basis points in late March, reaching its widest level since June 2025. Economists like Citi's Giada Giani note that while oil prices have increased, they remain below the ECB's June projections, and broader inflationary spillovers are still limited.
Commerzbank strategist Erik Liem highlighted that markets remain cautious due to renewed escalation risks in the Middle East, with oil prices continuing to climb. He also pointed out the difficult position the ECB faces compared to the Federal Reserve, as the momentum of oil prices and economic activity data from the eurozone are pushing outcomes towards more adverse scenarios related to Iran. The German two-year government bond yield, which is highly sensitive to interest rate expectations, also rose to 2.79% after touching 2.8174%, its highest level since July 2024, further indicating market anticipation of tightening monetary policy.
