Euro zone yields fall on Middle East hopes, 2026 ECB hikes priced

By Stefano Rebaudo

May 25 (Reuters) - Euro zone government bond yields fell on Monday as renewed hopes of a U.S.-Iran deal to reopen the Strait of Hormuz eased concerns over inflation and reduced expectations of aggressive central bank policy tightening.

Borrowing costs tracked moves in oil prices, which slid 5% amid optimism over a resolution of the conflict, even as key sticking points remained unresolved.

The United States will either have a good agreement with Iran or deal with the country "another way," Secretary of State Marco Rubio said on Monday.

Money markets priced in a European Central Bank depo rate at 2.57% in December from 2.67% late Friday, from the current 2%. They indicated an 70% chance of a first rise next month from 80%.

"It is unclear whether by mid-June there will be enough clarity and certainty around any potential deal to call off a (ECB) rate hike," said Benjamin Schroeder, senior rate strategist at ING.

"There is good reason for caution around the need for further tightening," he argued.

Schroeder noted Europe would benefit the most from a swift resolution to the disruption in the Strait of Hormuz, adding that the region's broader macroeconomic environment remains fragile.

Germany's 2-year yields, more sensitive to expectations for policy rates, fell 7 basis points (bps) to 2.5671, their lowest since May 7%. They reached 2.771% in late March, the highest since July 2024.

Germany's 10-year government bond yield, the euro area's benchmark, was down 5 bps at 2.9831%, its lowest since May 7. It reached 3.13% in late March, its highest level since June 2011.

Italy's 10-year government bond yields fell 6.5 bps to 3.70%.

The yield gap of Italian government bonds versus Bunds was at 71 bps. It was at 63 bps before the attack on Iran and hit 103.62 in late March, the highest level since June 2025.

(Reporting by Stefano Rebaudo; Editing by Bernadette Baum)