Euro zone long-dated government bond yields hit multi-year highs as the prospect of a prolonged conflict in the Middle East raised concerns that inflationary pressures may prove more persistent.
Investors fear not only higher inflation but also a rise in defence spending if geopolitical tensions persist, increasing debt issuance and adding to pressure on bond markets.
Germany's 10-year Bund yield was up one basis point to 3.21% after reaching 3.2158%, the highest since May 2011. The country's two-year bond yields, which are more sensitive to interest rate expectations, were roughly unchanged at 2.79%. Iran will conduct a military attack to break the U.S. naval blockade on the Islamic Republic, a senior Iranian official told Reuters.
Market participants have noted U.S. President Donald Trump has signalled a strategy that relies more on economic pressure through a naval blockade of Iran than on direct military action and described the current situation as a stalemate.
FRANCE'S FISCAL TRAJECTORY
"The risk of renewed escalation and prolonged disruption to Gulf trade (remains) firmly in place," Geoffrey Yu, strategist at BNY, said.
"As summer winds down, markets may soon face a harder test of whether resilience can survive once temporary supports fade," he added.
French bonds remain under pressure as investors fear France's fiscal trajectory is unlikely to improve ahead of a presidential election scheduled for spring 2027. Some analysts argued that, in a low-volatility environment, investors' search for yield could help limit any widening in the spread between French government bonds and safe-haven German Bunds.
France's 10-year government bond yields were up 1.5 bps at 4.05%, after hitting 4.0581%, the highest level since June 2009. Yields on 30-year government bonds reached 4.8617%, the highest since September 2008, up 2 bps on the day.
The yield gap between 10-year OATs and Bunds was at 84 bps, not far from its highest level since October 2025.
Money markets priced in a European Central Bank deposit rate of 2.76% in March 2027, up from the current 2.25%. They also implied a more than 90% chance of a September rate hike.
"We see it as a maximum one hike from the ECB," Mohit Kumar, an economist at Jefferies, said.
"Oil prices are currently lower than any of the adverse scenarios that the ECB presented in June and there is no need to deliver a series of hikes," he added. Oil prices, the main inflation driver, rose on a lack of progress in diplomatic efforts to resolve the Iran war, though the absence of major supply outages limited gains.
Italy's 10-year government bond yield rose 1.5 bps to 4.0%, while its 30-year counterpart hit 4.8254%, the highest since November 2023. The yield gap with Bunds was at 77 bps. It was at 63 bps in February before the attack on Iran and hit 103.62 in late March, the widest since June 2025.
