German bond yields set for biggest weekly rise in over a month

Euro zone bond yields fell on Friday, but German yields remained on track for their biggest weekly rise in over a month due to escalating tensions in the Iran war.

Euro zone bond yields fell alongside oil prices on ​Friday, but German yields were still ​on track for their biggest weekly rise ‌in ​more than a month after this week's escalation in the Iran war. The two-year German yield, which is sensitive to expectations for European Central Bank ‌interest rates, is up 10 basis points this week, its biggest weekly rise in five weeks. The 10-year yield, the benchmark for the euro zone, has risen by a similar amount, its biggest weekly increase since ‌early May.

Renewed U.S.-Iran attacks led traders to increase bets on the chance of two rather than one ‌more ECB rate hike this year following June's move, pushing yields higher. On Friday, however, euro zone bond yields fell for a second straight session as traders bet the latest escalation was unlikely to develop into a full-scale war. Brent crude fell ⁠to around $75 ​a barrel after rising ⁠above $80 earlier in the week.

Washington remains committed to finding a resolution with Iran and "technical talks continue", a U.S. official said. Germany's 10-year ⁠yield was last down 1 bp to 3.04%, below the more than one-month high of 3.09% touched on ​Thursday. The two-year yield fell a similar amount to 2.64%.

Traders were pricing in 32 bps of ⁠ECB rate hikes by year-end on Friday, implying one further increase and roughly a 30% chance of a second. That was down ⁠from ​36 bps earlier in the week. A rally in Japanese government bonds overnight, after reports that Tokyo wants to explore ways to encourage pension funds to increase holdings of domestic assets, also supported European bonds ⁠on Friday, Commerzbank analysts said. However, they warned this was a risk in the longer run if ⁠Japanese investors repatriate funds from ⁠abroad.

Japan's foreign bond holdings "have been declining gradually in recent years but remain significant. In Europe, France is most exposed with Japanese investors still holding some €128 billion at ‌the end of ‌last year," the analysts said.