Markets price three ECB rate hikes in 2026 as Iran de-escalation hopes fade

By Stefano Rebaudo

April 2 (Reuters) - Euro zone benchmark Bund yields snapped a three-day decline on Thursday and traders raised bets for central bank interest rate hikes as hopes of de-escalation in the Middle East conflict faded.

Money markets priced in an ECB deposit facility rate of 2.75% at year-end, from 2.68% late Wednesday. The rate is currently 2%.

German borrowing costs were still on track for their first weekly drop since the beginning of the war as investors scaled back their bets for future European Central Bank rate hikes on expectations for a quick end to the conflict earlier this week.

Germany's 10-year government bond yield rose 3 basis points (bps) to 3.03% and was set for a 7-bp weekly drop. It reached 3.13% last Friday, its highest level since June 2011. U.S. President Donald Trump vowed more aggressive strikes on Iran in a Wednesday evening prime-time speech.

Meanwhile, Tehran will press on with the Middle East war until the United States and Israel face "permanent regret and surrender", a spokesperson for its armed forces' unified command said.

Oil prices have jumped since early March, fuelling inflation fears and expectations for rate hikes at the ECB and elsewhere.

Germany's 2-year yields, more sensitive to expectations for policy rates, were up 4.5 bps at 2.65%. They were on track for a 2-bp weekly decline.

Italy's 10-year government bond yields rose 8 bps to 3.93%, after reaching 4.142% last Friday, the highest since July 2024.

The yield gap between Italian government bonds and Bunds stood at 89 bps. It was at 63 bps before the start of the war, and had dipped to 53.50 in mid-January, its lowest level since August 2008.

The French spread over Bunds was at 71 bps from 58 bps before the conflict. (Reporting by Stefano Rebaudo; Editing by Kevin Buckland)