Euro zone yields drop as US, Iran pause strikes; Fed also in focus

Euro zone government bond yields fell on Monday as easing oil prices and hopes of a diplomatic solution between the US and Iran reduced short-term inflation fears.

Government bond yields across the euro zone fell on Monday ​as easing oil prices helped soothe short-term inflation fears following ​U.S. President Donald Trump's decision to suspend attacks ‌on ​Iran. Oil prices tumbled 9.5% after the U.S. and Iran paused strikes over the weekend, raising hopes of a diplomatic solution that would de-escalate the conflict and allow shipping to resume in the ‌Strait of Hormuz.

Germany's two-year yields, more sensitive to expectations for policy rates, fell 4.3 basis points to 2.777%, after reaching a two-year high of 2.8938% last week. Money markets slightly scaled back bets on European Central Bank rate hikes, pricing a deposit rate of 2.68% in December and 2.73% ‌in February 2027 from the current 2.25%. Last week, they fully priced a depo rate at 2.75%.

The ECB still considers ‌the current inflation shock to be medium-sized, which requires some policy action but not aggressive moves, and it will get price growth back to 2% in the next year or so, ECB chief economist Philip Lane said. The central bank kept interest rates unchanged as expected on Thursday but held the door open to another increase ⁠in September.

Germany's ​10-year government bond yield, the euro zone's ⁠benchmark, was down 5 bps at 3.124%. It reached 3.2118% last week, its highest since May 2011. German business morale grew more than forecast in July on ⁠a significant improvement in expectations, a survey showed on Monday.

“A packed agenda with high-profile data cluster on Thursday and several central bank decisions could add to ​the relief and also decisively shape the direction for yields, curves and spreads for the rest of the summer,” said Commerzbank ⁠strategist Rainer Guntermann, mentioning upcoming U.S. inflation figures due after the Federal Reserve's policy meeting. Investors will closely watch the Fed meeting for signals on how Chair Kevin Warsh views ⁠energy-driven ​risks.

A growing chorus of policymakers recently argued rates may need to rise, setting up a charged debate at the Fed, though markets are still betting rates will stay on hold. Traders are pricing in a 33.7% chance of a hike, according to CME Group's ⁠FedWatch Tool, up from 12% roughly two weeks ago.

Markets do not expect any action on rates from either the Bank of Japan or ⁠the Bank of England on ⁠Thursday. Italy’s 10-year government bond yields fell 6 bps to 3.942%.

The spread between Italian government bonds and Bunds was at 79 bps. It stood at 63 bps in February before the attack on Iran, and ‌hit 103.62 in ‌late March, the highest level since June 2025. (reporting by Stefano Rebaudo. Editing ​by Andrei Khalip and Mark Potter)