German yields set for fourth straight weekly rise, natural gas prices in focus

German government ‌bond ​yields were on track for a fourth consecutive weekly rise, the biggest since mid-July, as investors bet central banks would keep policy restrictive to contain persistent inflation pressures in a resilient economy.

Investors watched natural gas and oil ‌prices which headed for a weekly gain, as renewed U.S.-Iran hostilities heightened concerns over Middle East supply risks. Analysts said that markets are becoming more sensitive to European gas than to crude alone as the euro zone has been shifting away from Russia-Ukraine and Middle East supply and favoured Norway and U.S. alternatives. They ‌also flagged the lower-than-average gas storage levels.

Gas prices eased on Friday morning but remain near their highest levels since January 2023 as the ‌market continues to assess how Europe's low storage situation and competition for liquefied natural gas (LNG) will shape prices this winter. Meanwhile, Iranian sources said a U.S. campaign to throttle Iran's economy by blockading its oil exports and stopping sanctions evasion is growing increasingly difficult to withstand.

Germany's 10-year bond yield was flat at 3.35%, set for a weekly rise of 7.5 bps. A survey showed ⁠on Tuesday ​that growth in the euro zone's manufacturing ⁠sector hit its fastest pace in more than four years in August, while inflation rose back above 3% on higher energy costs.

German two-year bond yields rose 0.5 bps to 2.96% ⁠while heading for a weekly rise of 6.5 bps, the steepest since mid-July. Traders were pricing the European Central Bank's deposit rate at 2.73% by December, implying a roughly 90% ​probability of a second rate hike after the widely expected increase later this month, from the current 2.25%.

Markets continued to build momentum towards ⁠further policy tightening, with the policy rate last seen at 3% by September 2027, down from 3.1% on Wednesday. The ECB will likely raise interest rates on September 10 for the second ⁠and ​final time in what would be its shortest hiking campaign in 15 years, according to a Reuters poll.

Italy’s 10-year government bond yields were flat at 4.18%. The yield gap versus safe-haven Bunds was at 80 bps, down from 81.7 bps the day before. The spread between French government bonds ⁠and Bunds was at 85 bps after reaching 90 bps earlier this week, its widest since November 2024, as investors worried about a perilous annual budget ⁠battle in the coming months.

"OATs ⁠performed well on Thursday after supply was absorbed reasonably well, and the front-end euro strip remained bid," Evelyne Gomez-Liechti, multi-asset strategist at Mizuho, said. "This allowed for some partial reversal of the recent OAT underperformance. However, with the 2027 budget ‌negotiations around the corner, we ‌still think OATs are not out of the woods," she added.

(reporting by ​Stefano Rebaudo; editing by Alexandra Hudson)