Global oil prices climbing past $100 per barrel have prompted traders to increase their expectations for interest rate increases in Europe, sending European government bonds sharply lower and pushing Germany's two-year bond yield to its highest level in more than two years.
Traders are stepping up their wagers on monetary tightening by both the European Central Bank and the Bank of England. Swap markets currently indicate that both central banks could implement as many as four additional rate increases by the end of 2027. Market consensus broadly anticipates the ECB will announce a tightening of monetary policy on Thursday.
Germany's two-year bond yield rose as much as 8 basis points to 3.078%, its highest level since June 2024. Shorter-dated bonds led the decline, causing the yield curve to flatten in a bearish manner. UK gilts also came under pressure, with the two-year yield rising 10 basis points to 4.69%.
Following the ECB's monetary policy decision on Thursday, investors will carefully scrutinize President Christine Lagarde's remarks for clues regarding any further policy tightening. The broad decline in European government bonds also highlighted fiscal risks, with French bonds showing particularly notable weakness. The yield spread between French and German 10-year bonds widened to 89 basis points into the close, poised for its highest closing level since 2012.
Market overview: Germany's 10-year bond yield rose 6 basis points to 3.43%; German bond futures fell 66 ticks to 121.38; Italy's 10-year bond yield climbed 8 basis points to 4.27%; the Italy-Germany yield spread widened 3 basis points to 84 basis points; France's 10-year bond yield advanced 9 basis points to 4.32%; and the 10-year UK gilt yield gained 8 basis points to 5.25%.
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