Euro zone bond yields fall after signs of progress in US-Iran talks, Lagarde comments

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

‌Euro ​zone government bond yields fell 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 over 3% lower at $77.84, ‌helping to calm fears over euro zone growth and inflation. Germany's 10-year bond yield, the benchmark for the bloc, was down 3.5 basis points (bps) at 2.951%. 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: ONE AND ⁠DONE? The European Central ​Bank became the first major central ⁠bank to raise interest rates since the start of the conflict earlier in June, in an attempt to curb inflation before rising energy costs spread more broadly across the economy. European Central Bank President Christine Lagarde ⁠on Monday told the European Parliament that there was no evidence yet of de-anchoring or second-round inflation effects that would warrant more forceful policy action, suggesting that the central bank could take time ​before deciding whether to raise rates again. Markets slightly trimmed their expectations for tightening by year-end, with futures pricing in about 31 bps of rate hikes, down ⁠from around 35 bps before Lagarde's comments.

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 5.5 bps at 2.588%. 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 3.5 bps at 4.808% after ‌Wes Streeting, another expected ‌leadership candidate, said he would support Burnham to become prime minister.