European bond market: Short-term yields on German and UK government bonds rise with oil prices, as ECB rate hike bets intensify

With fears that a potential escalation in the Iran war could push up oil prices, money-market participants have increased their bets on further interest-rate hikes by the European Central Bank, and Germany’s government-bond yield curve has flattened. The rise in yields is driven mainly by higher real interest rates; the break-even inflation rate has fallen, indicating that the market believes the central bank will carry out its mandate and keep inflation within the target range.

The swap market shows that investors currently expect the ECB to raise rates by 76 basis points this year, higher than the 64 basis points priced in on Monday; they also expect a 20 basis point hike at next month’s meeting.

As volatility jumps, Italian government bonds across the curve are lagging behind other euro-zone countries’ bonds.

UK government bonds in the short end have underperformed the rest of the curve, as traders have raised their bets on the Bank of England for rate hikes within the year; meanwhile, traders are also positioning ahead of the UK’s February CPI data, set to be released before trading opens on Wednesday.

The swap market shows that investors expect the Bank of England to tighten by 69 basis points, higher than the previously expected 62 basis points.

Market:

Germany 10-year government bond yield rose by 1 basis point to 3.02%;

Germany government bond futures fell by 8 points to 125.37;

Italy 10-year government bond yield rose by 5 basis points to 3.93%;

France 10-year government bond yield rose by 2 basis points to 3.74%;

UK 10-year government bond yield rose by 2 basis points to 4.94%.

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