Money markets still price in two ECB hikes as Iran tensions weigh

By Stefano Rebaudo Euro zone government bond yields fell on Wednesday after rising the previous day, as investors continued to expect two European Central Bank rate hikes this year amid uncertainty over U.S.-Iran tensions. Borrowing costs tracked moves in oil prices, which pulled back from recent highs on Wednesday, erasing some of the previous day's 4% gain. Iran said on Tuesday the U.S. had violated a ceasefire by striking targets near the contested Strait of Hormuz, potentially complicating efforts to bring the war to a close.

Money markets are pricing the ECB deposit rate at 2.59% by December, up from the current 2% but down from the 2.75% level priced in last week. They also indicated an 80% chance of a first rise next month. ECB board member Isabel Schnabel said the central bank should raise interest rates in June, even if ongoing peace talks with Iran yield a deal. Germany's 2-year yields, more sensitive to expectations for policy rates, fell 2.5 basis points to 2.57%. They reached 2.771% in late March, the highest since July 2024 and dropped to 2.523% early this week, their lowest since May 7. Germany's 10-year government bond yield, the euro area's benchmark, was down 2 bps at 2.96%. It reached 3.13% in late March, its highest level since June 2011. Italy's 10-year government bond yields fell 3 bps to 3.69%. The yield gap of Italian government bonds versus Bunds was at 70 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 Andrew Cawthorne)