Euro zone government bond yields were slightly higher on Tuesday as Brent crude futures rose back above $90 per barrel, threatening the inflation outlook and strengthening the case for tighter policy from the European Central Bank.
Investors were also watching Britain's gilt market after new Prime Minister Andy Burnham picked former defence minister John Healey — who was a junior minister in the Treasury from 2002 to 2007 — as his finance minister.
Germany's yields climb on ECB tightening expectations
Germany's 10-year bond yield DE10YT=RR was up over 2 basis points (bps) at 3.175%, its highest level in over eight weeks.
Bond markets have been driven by energy prices in recent weeks, according to Hauke Siemssen, rates strategist at Commerzbank.
Energy prices have been rising following military strikes by both the United States and Iran, with maritime traffic through the vital Strait of Hormuz chokepoint effectively shut down.
Brent futures rose over 2% on Tuesday but were just below a five-week high reached on Monday of $91.42 per barrel. Benchmark Dutch wholesale gas prices TFMBMc1 rose to their highest intraday level in four months on the same day, adding to worries about inflation before the ECB's policy announcement on Thursday.
Markets expect the central bank to hold its deposit rate steady at 2.25%, following a rate rise in June.
Further ahead, investors were pricing in about 45 basis points of tightening from the ECB by the end of the year, or the equivalent of one quarter-point rate hike and an 80% chance of a second.
"What the market is pricing in terms of ECB hikes is a lot," said Commerzbank's Siemssen.
"A hike in September can be justified with the inflation figures, but then I think the bar will be high for another hike into restrictive territory as they have to keep an eye on growth," he added.
Germany's two-year bond yield DE2YT=RR, which is sensitive to changes in ECB policy expectations, was up 1.5 bps at 2.793% after touching a two-year high of 2.8174% on Monday.
UK gilts slightly outperform after minister appointment
Meanwhile, Britain's gilts slightly outperformed after PM Burnham's choice of Healey as finance minister.
"The Prime Minister’s surprise pick ... might help at the margin, as he was seen as more market-friendly than most alternatives," said Rob Wood, chief UK economist at Pantheon Macro.
Britain's benchmark 10-year gilt yield GB10YT=RR was flat at 5.034%. Bond yields move inversely with prices.
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