European government bonds fell on Monday as oil prices climbed above $100 per barrel for the first time since May, prompting money markets to significantly increase their bets on central bank interest rate hikes.
Swaps are now almost fully pricing in a 25-basis-point rate hike by the European Central Bank in both September and December, with roughly a 90% probability of a third increase by next June.
Traders showed a muted reaction to the ECB's decision to hold rates at 2.25% and to President Christine Lagarde's press conference. According to sources, ECB officials are prepared to raise rates in September unless there is a significant improvement in the eurozone inflation outlook.
The yield on the 10-year German government bond rose to its highest level since 2011 ahead of the ECB's rate decision and held steady at that level.
Italian and French government bonds underperformed the safer German Bunds, pushing the Italian-German yield spread to its widest since early May on a closing basis. The French-German yield spread also widened to its most in two weeks.
UK gilts fell, with longer-dated bonds slightly outperforming. Traders also increased their bets on Bank of England rate hikes; for the first time in over a week, the market fully priced in two 25-basis-point rate increases by year-end, and completely priced in a third increase by mid-next year.
Market summary:
German 10-year bond yield rose 4 bps to 3.21%;
German bond futures fell 34 ticks to 124.13;
Italian 10-year bond yield rose 6 bps to 4.05%;
Italian-German yield spread widened 3 bps to 85 bps;
French 10-year bond yield rose 6 bps to 4.03%;
10-year UK gilt yield rose 8 bps to 5.11%.
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