Euro zone bond yields up as Hormuz risks outweigh weak PMI data

By Stefano Rebaudo

April 23 (Reuters) - The euro zone's short-dated government bond yields ticked lower on the heels of weak economic data, but remained on track for their fourth daily rise as tensions around the Strait of Hormuz bolstered expectations of European Central Bank rate hikes.

Borrowing costs have tracked gains in oil prices, which have stoked concerns about inflation and raised the prospect of a hawkish response from the ECB.

The euro zone suffered a surprise contraction in April with the U.S.-Israeli war on Iran sapping demand as prices soared, the S&P Global Flash Eurozone Composite Purchasing Managers' Index showed. Business activity in the private sector shrank at the quickest pace in 14 months in France and it slipped back into contraction in Germany for the first time in nearly a year.

Citi flagged that euro area input costs increased at the fastest pace since the end of 2022, and output price inflation hit a 37-month high.

Germany's 2-year yields, more sensitive to expectations for policy rates, rose 2.5 basis points to 2.57%. They reached 2.771% in late March, the highest since July 2024.

"The current PMI report shows that, despite the slowdown, some second-round price effects are already arising," said Peter Vanden Houte, chief economist, euro zone, at ING.

"That might push the central bank into at least one rate hike later this year, to prevent the current inflation increase from raising inflation expectations," he added.

ECB chief economist Philip Lane said on Wednesday the ECB would not be able to say whether the shock from the Iran war on the euro zone's economy was fleeting or more profound until it became clear how long the conflict would last.

Germany's 10-year government bond yield rose 2.5 bps to 3.02%. It reached 3.13% in late March, its highest level since June 2011.

Iran tightened its grip on the Strait of Hormuz after U.S. President Donald Trump said he would indefinitely call off attacks, with no sign of peace talks restarting.

Money markets priced in an ECB deposit facility rate at 2.63% by the end of the year - implying two hikes and about a 50% chance of a third move - from around 2.35% late on Friday.

Italy's 10-year government bond yields rose 4.5 bps to 3.83%. The yield gap of Italian government bonds versus bunds was at 78 bps. It was at 63 bps before the attack on Iran and hit 103.62 during the conflict, the highest since June 2025. (reporting by Stefano Rebaudo; editing by Alex Richardson)