The yield on Germany's 10-year Bund reached 3.20% on Thursday, marking its highest level in over 15 years. This surge was driven by renewed inflation concerns stemming from the war in the Middle East and blockades in the Red Sea and Persian Gulf, which have caused natural gas benchmarks to soar to three-year highs and crude oil prices to exceed $90 a barrel. The European Central Bank (ECB) had previously signaled its vigilance against inflationary risks and delivered a rate hike in June, with money markets now pricing in at least two additional rate hikes by year-end, most likely in September.
Despite the expectation that the ECB will keep interest rates unchanged at its upcoming policy meeting this week, the escalating oil prices have reignited inflation concerns, reinforcing expectations for a more hawkish stance in the future. Deficit spending in Germany, France, and Italy has also contributed to rising yields across the curve. While an ECB survey indicated more moderate growth in wage and selling-price expectations, suggesting limited second-round inflation effects, the central bank must weigh these signals against the risk of a prolonged energy shock becoming embedded in economic behavior.
Money markets fully price a September rate increase, with the implied ECB deposit rate projected to reach 2.75% by February 2027, up from the current 2.25%. Germany's policy-sensitive two-year government bond yield also climbed to a two-year high of 2.8174%, indicating investor expectations for tighter monetary policy. The spread between Italian and German 10-year bond yields widened to 80 basis points, reflecting heightened concerns over geopolitical risks and sovereign debt markets, though remaining below its March peak. Citi economist Giada Giani noted that recent oil price rises are still below the ECB's June assumptions, and broader inflationary spillovers remain limited.
