On Monday, driven by market expectations that the European Central Bank will implement two more interest rate hikes by early 2027, the yield on Germany's two-year government bonds surged to a two-year high before subsequently giving up those gains. Borrowing costs in the Eurozone fluctuated in tandem with movements in oil prices. International crude oil prices experienced a sharp decline following news regarding US-Iran negotiations. At the time of writing, WTI crude futures were down 2.04% to $80.11 per barrel, while Brent crude futures fell 1.59% to $86.70 per barrel, having earlier breached the $90 mark. Reports indicate that negotiations between the US and Iran have not completely broken down despite ongoing cross-border fire. Iran's Foreign Ministry stated on Monday that it is prepared to continue talks with the United States based on national interests. Ministry spokesman Nasser Kanaani mentioned that Iran has received proposals from mediators involved in the US-Iran talks, though specific details are not yet available for disclosure. He added that Iran's Interior Minister would visit Pakistan the same day to discuss bilateral matters. Furthermore, reports suggest mediators have proposed a 10-day ceasefire to discuss reviving the interim agreement between Iran and the US.
The yield on Germany's interest rate-sensitive two-year government bonds was flat at 2.78%, after reaching 2.8174% earlier, its highest level since July 2024. Money markets are pricing in a European Central Bank deposit rate of 2.67% by December and 2.75% by February 2027, up from the current 2.25%. Additionally, markets have fully priced in a rate hike for September. Analysts point out that the strong correlation between oil prices and short-term interest rates in the Eurozone has re-emerged, a dynamic that dominated market movements from March to May this year, with recent heightened geopolitical risks reinforcing this linkage once more.
The yield on Germany's 10-year government bond, considered the Eurozone benchmark, rose by 1 basis point to 3.13%. In mid-May, this yield had reached 3.20%, its highest level since May 2011. Market participants continue to anticipate that the European Central Bank will keep interest rates unchanged at its upcoming policy meeting later this week. Citi economist Giada Giani noted, "Despite renewed Middle East tensions and rising oil prices, they remain slightly below the baseline assumptions from June, and signs of second-round effects are still limited."
A survey released by the European Central Bank on Monday indicated that businesses in the Eurozone expect a more moderate pace of sales price increases and a slowdown in wage growth, providing further evidence that the recent energy-driven inflation spike has not yet triggered significant secondary price effects. Societe Generale commented, "While crude oil prices remain well below their spring highs, refined product prices are telling a different story, with diesel and gasoline behaving as if crude were at $110 to $120 per barrel."
"For the European Central Bank, a source of comfort is that the primary driver of this price increase remains crude oil. Although natural gas and electricity prices are also rising gradually, they have not yet become a major source of inflationary pressure."
The yield on Italy's 10-year government bond increased by 1.5 basis points to 3.96%. The yield spread between 10-year Italian and German government bonds stands at 80 basis points. Prior to the attacks on Iran in February, this spread was 63 basis points, widening to 103.62 basis points by the end of March, marking the largest gap since June 2025. This spread is a key gauge of financial risk, market sentiment, and fragmentation risk within the Eurozone financial system.
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