European government bonds continued to face selling pressure on Friday, extending a recent trend where borrowing costs for several nations have climbed to multi-decade highs.
On Thursday, the yield on Germany’s ten-year government bond—widely regarded as the benchmark for the eurozone—surged to its highest level since the peak of the eurozone crisis in mid-2011. During early trading on Friday, the yield rose an additional 6 basis points to 3.1228%, holding above its 15-year peak.
Bond yields move inversely to prices, and one basis point equals 0.01%.
French government bond yields also extended their climb on Friday, with the ten-year OAT yield rising 9 basis points, similarly hovering near its highest level since 2011. The previous day, the French ten-year yield had surged by approximately 14 basis points.
Last week, UK government borrowing costs reached their highest level since the 2008 financial crisis, as investors rushed to price in renewed inflation expectations and bets that the Bank of England would adopt a more hawkish policy stance. The benchmark UK ten-year gilt yield rose another 10 basis points on Friday to 5.07%, bringing its one-month increase to 83 basis points.
This sharp sell-off followed remarks by European Central Bank President Christine Lagarde, who indicated that the ECB is prepared to raise its key interest rates even if the inflation spike triggered by the U.S.-Iran conflict proves temporary.
At the same time, bonds issued by other eurozone economies—including Spain, Italy, Portugal, Greece, Poland, the Netherlands, and Belgium—also experienced significant volatility.
In an interview published the same day, Lagarde described market expectations of a quick economic recovery after the Iran conflict as "overly optimistic." She stated that energy supply losses from the Gulf region "cannot" be restored within months and warned that such disruptions could persist for years.
Prior to the outbreak of the Iran conflict in late February, eurozone inflation had fallen below the ECB’s 2% target. However, in February, the rate edged up to 1.9%.
The conflict and the subsequent blockade of the Strait of Hormuz—a critical shipping route—have driven a sharp increase in global oil and gas prices, disrupting inflation forecasts across Europe. The continent remains heavily dependent on energy imports and is still grappling with the energy shock caused by the Russia-Ukraine war and related sanctions on Russian exports.
Markets are now pricing in a more than 90% probability of an ECB rate hike by June.
On Friday, Spain released preliminary inflation data—the first such reading from the eurozone since the U.S.-Iran conflict began in late February. The figures showed annual inflation reached 3.3%, below the 3.7% expected by economists polled by Reuters.
Nevertheless, there are signs that the conflict is beginning to affect economic activity across the continent. A GfK survey this week indicated that German consumer confidence has been hit, with respondents expecting their incomes to suffer amid rising inflation concerns. In a corresponding UK survey released Friday, analysts noted that expectations of sharp price increases are sending "ripples of panic" among British consumers.
Yields to Peak When Energy Prices Do
Jim Reid of Deutsche Bank wrote in a Friday morning report, "Growing concerns over a stagflationary shock are weighing on bond markets, with particularly sharp moves in European sovereigns."
He added that, given the ongoing conflict, Deutsche Bank’s European economists have raised their forecast for March annual inflation from 1.89% to 2.58%.
James Bilson, a global flexible fixed income strategist at Schroders, told CNBC that energy prices "remain without question" the most important driver of moves in European bond markets.
In a Friday email, he stated, "Calling the top in yields is like catching a falling knife—it’s hard to escape the simple conclusion that yields will peak when energy prices peak. The ECB last week outlined three scenarios in its projections: 'baseline,' 'adverse,' and 'severe.' At current prices, we are between the baseline and adverse scenarios but moving toward 'adverse.' We see this as consistent with at least a few ECB rate hikes. If energy prices push us into the 'severe' scenario, then anything is possible."
Arend Kapteyn, Global Head of Economics and Strategy Research at UBS, said on Friday that bond market movements reflect a "bear flattener," where shorter-dated bond yields rise significantly.
He noted, "If the economy falls into recession, then we will see a large-scale bull steepener again, essentially pulling those short-term yields back down. If oil reaches $130 per barrel and eventually stabilizes around, say, $100, I really think the ten-year yield will settle around 3% or slightly above. But in a scenario where the Fed might start cutting rates, these bond yields could fall all the way back."
According to the CME Group’s FedWatch tool, money markets currently assign a 93.8% probability that the U.S. Federal Reserve will keep rates unchanged at its next meeting in April.
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