Euro zone government bond yields rise as safe-haven demand recedes

The 10-year government bond yield, the euro zone's benchmark, was up 6 basis points (bps) at 2.42%, after dropping 11.8 bps on Friday in its biggest daily fall since Oct. 9, the Monday after Palestinian Islamist group Hamas attacked Israel.

Euro zone government bond yields rose on Monday after plunging on Friday, as the latest developments eased fears of an immediate escalation in the Middle East conflict. Iran ended its retaliatory attack with no significant damage to Israel, and Washington said it did all it could to avoid open warfare erupting between the two countries.

Borrowing costs in the euro area extended their rise somewhat after stronger than expected U.S. retail sales data suggested consumers are weathering high interest rates, reducing the need for rate cuts. The 10-year government bond yield, the euro zone's benchmark, was up 6 basis points (bps) at 2.42%, after dropping 11.8 bps on Friday in its biggest daily fall since Oct. 9, the Monday after Palestinian Islamist group Hamas attacked Israel. Bond prices move inversely with yields.

"The week is starting on a fraught note, with unease still clouding sentiment. Investors are on alert for retaliatory action following Iran's attack on Israel," said Susannah Streeter, head of money and markets at Hargreaves Lansdown. The U.S. benchmark 10-year yield reached 4.626%, its highest since November, up 11 bps.

Analysts said if Bund yields saw upward pressure from developments in U.S. Treasuries, financial conditions could be overly tight in the euro zone, and the European Central Bank would have to respond with easier monetary conditions. The gap between the 10-year U.S. Treasury and German rates hit a fresh 4-1/2 year high as yields rose more in the U.S. than in the euro area, with markets expecting the Federal Reserve to be more hawkish than the ECB.

It was at 217.53 after reaching 219.95 early in the session, its highest level since mid-December 2019. While Fed officials reiterated there was no urgency to cut rates and supported expectations for two Fed moves this year, ECB rate-setters argued the ECB could ease its monetary policy even if the Fed does not.

Lithuanian ECB policymaker Gediminas Simkus said there was a greater than 50% probability of more than three rate cuts in 2024. Francois Villeroy de Galhau said the ECB was confident of winning the inflation fight, while ECB chief economist Philip Lane said inflation was heading to 2% after a bumpy road. Money markets are pricing in 83 bps of ECB rate cuts in 2024 from 87 bps late on Friday.

Derivatives on U.S. rates price in 40 bps of rate cuts in 2024, discounting a 60% chance of a second rate cut this year from around 50% last week after U.S. inflation data. Italy's 10-year yield, the benchmark for the euro area's periphery, rose 5 bps at 3.79%.