Euro zone bond yields rise as traders eye three ECB hikes in 2026

By Stefano Rebaudo

June 3 (Reuters) - Euro zone government bond yields rose on Wednesday, with traders now pricing in a more than 50% probability of three European Central Bank rate hikes by year-end as U.S.-Iran peace talks stalled.

Investors stayed wary about the possibility of a deal between the U.S. and Iran that could reopen the Strait of Hormuz, as such a development would likely reduce energy-driven inflationary pressures and weaken expectations of further central bank tightening. Gulf hostilities flared again on Wednesday as an Iranian missile attack damaged Kuwait's airport and the U.S. military carried out strikes near the Strait of Hormuz. Money markets are pricing the ECB deposit rate at 2.66% by December, which implies two rate hikes and an about 65% chance of a third move. They also indicated a 90% chance of a first rise this month. The ECB is expected to raise its deposit rate to 2.25% on June 11, with another increase likely in September, as it balances energy-driven inflation against a weakening economy, a Reuters poll of economists showed. Germany's 2-year yields, more sensitive to expectations for policy rates, rose 5 basis points (bps) to 2.67%. They reached 2.771% in late March, the highest since July 2024.

Markets are closely watching the ECB's possible rate outlook, while a likely future increase in fiscal spending is also under the spotlight.

"This is the third energy crisis for Europe since 2000. We had COVID, Ukraine, Iran, each one of these crises required fiscal spending because governments need to support the industry and the consumer," Yoram Lustig, head of global investment solutions at T. Rowe Price, said.

"This is bad for government bonds," he added. Germany's 10-year government bond yield, the euro area's benchmark, was up 4.5 bps at 3.02%. It reached 3.13% in late March, its highest level since June 2011.

Investors are also looking ahead to the U.S. employment report due on Friday, which could shape the Federal Reserve's policy path. A stable labour market would reinforce financial market expectations that the Fed will keep rates stable into next year, while monitoring the inflation fallout from the Middle East conflict. Italy's 10-year government bond yields rose 6 bps to 3.76%, with the yield gap of Italian government bonds versus Bunds at 72 bps.

(reporting by Stefano Rebaudo; Editing by Emelia Sithole-Matarise)