Euro zone bond yields fall slightly after signs of progress in US-Iran talks

Euro zone government bond yields dipped on Monday as renewed optimism in US-Iran peace talks eased worries over the Middle East conflict and its impact on euro zone growth and inflation.

‌Euro ​zone government bond yields dipped on Monday on signs that progress had been made in peace talks between the U.S. and Iran over the weekend, easing worries that the process to end the Middle East conflict was breaking down. Mediators ‌said a communications line had been set up to help ensure safe passage for commercial ships through the Strait of Hormuz. Tehran's Islamic Revolutionary Guard Corps had declared the Strait shut on Saturday, though the U.S. military said commercial vessels had continued operating in the waterway.

The renewed optimism helped Brent crude futures to reverse earlier gains ‌to stand 1.8% down at $79.09, helping to calm fears over euro zone growth and inflation. Germany's 10-year bond yield, the benchmark for the bloc, was down ‌2 basis points (bps) at 2.964%. It rose 6 bps on Friday after peace talks halted abruptly, highlighting the fragile nature of the current ceasefire.

"The renewed closure of the Strait of Hormuz will add to the markets' wariness about swift progress towards a U.S.-Iran agreement," Commerzbank rates strategist Rainer Guntermann said in a note. "As such, any rebound in Bunds is likely to remain limited while the ⁠3% handle ​for 10-year yields should provide support."

ECB ⁠POLICY UNCERTAINTY European Central Bank President Christine Lagarde is scheduled to testify before the European Parliament on Monday. Her comments could give a steer on how the central bank assesses the current situation and ⁠whether it could tighten policy further after becoming the first major central bank to raise interest rates since the start of the conflict.

Markets are still pricing in about 35 ​bps of tightening by the end of the year, implying one quarter-point increase and about a 40% chance of another. After the ECB raised ⁠rates on June 11, markets had been pricing in about 40 bps of tightening by the December policy meeting. "It's really difficult for the ECB to rule out another rate hike even with a peace ⁠agreement ​and if oil prices are below $80 as they are still worried about upside risks to inflation," said Anders Svendsen, chief analyst at Nordea Markets.

"It's difficult to take out the rate hike pricing in the euro curve and that's keeping the market in a bit of limbo." Germany's two-year yield, which is ⁠sensitive to changes in ECB rate expectations, was down 1 bp at 2.634%. Investors were also watching for possible contagion from Britain after Prime Minister Keir Starmer ⁠announced his intention to resign, paving the ⁠way for a new leader.

Andy Burnham, who is expected to be more open to looser fiscal policy than Starmer, is the clear frontrunner to become the new prime minister. Britain's 10-year gilt yield was down 3 bps at 4.812% after ‌Wes Streeting, another expected leadership candidate, ‌said he would back Burnham to become prime minister.