Euro zone yields stall on mixed Middle East signals, ECB in focus

By Stefano Rebaudo

June 11 (Reuters) - Euro zone government bond yields edged down on Thursday, reversing an earlier rise, as investors watched moves in oil prices and tensions in the Middle East ahead of the European Central Bank's policy decision later in the day.

Efforts to reach a preliminary deal between Iran and the U.S. have intensified, Iranian sources told Reuters on Thursday, despite strikes launched by both sides, as they discuss a mechanism for releasing frozen Iranian funds.

An agreement that reopens the Strait of Hormuz would ease constraints on energy supplies, helping to dampen inflation pressures, reduce expectations of further monetary tightening and push bond yields lower.

"We remain optimistic that a deal would eventually be reached, but last two days' events have been a setback for our optimistic view," said Mohit Kumar, an economist at Jefferies.

"They are not totally surprising as the 'No war, No peace' scenario was stretching for too long and testing Trump's patience," he added.

Markets widely expect the ECB to raise interest rates by 25 basis points and will closely watch any signals about the future policy path.

Germany's 2-year yields, more sensitive to expectations for policy rates, fell 0.5 basis points to 2.70%. They reached 2.771% in late March, the highest since July 2024.

"It seems highly unlikely that the ECB signals one-and-done. More likely, in our view, is that President Lagarde leaves a strong impression that the base case is that another hike will follow," Jamie Searle, European rate strategist at Citi, said.

"The bearish risk (for bond prices) is that the ECB aims to get slightly ahead of the curve and talks up the chance of a back-to-back hike in July," he added, arguing that such a risk was likely mild.

HAWKISH MARKET PRICING

Money markets indicated the ECB deposit rate at 2.70% in December, from the current 2%. They also fully priced a rate hike in September and indicated a 40% chance of such a move in July.

"The hawkish market pricing gives the ECB extra time to act, which means President Lagarde doesn't have to commit to future hikes," Michiel Tukker, rate strategist at ING, said.

"Opening the door to July would be part of the more hawkish outcomes," he added.

Germany's 10-year government bond yield, the euro area's benchmark, was flat at 3.07%. It reached 3.20% in mid-May, its highest level since May 2011.

Italy's 10-year government bond yields fell 0.5 bps to 3.84%. (reporting by Stefano Rebaudo; editing by Alex Richardson)