Euro zone bond yields steady as oil pulls back

Declining oil prices and optimism about a possible diplomatic resolution to the US-Iran war have supported bonds so far this week.

While US President Donald Trump warned on Tuesday that he could "annihilate" Iran, he also said his envoys Steve Witkoff and Jared Kushner had held productive talks with mediators of Iran to end the war.

Hopes for an agreement and optimism around improved supply after Saudi Arabia restarted operations at a critical pipeline pushed oil prices lower. Brent crude futures LCOc1 were last down 0.65% on the day at $98.61 a barrel, around a two-week low.

The recent surge in energy prices had fuelled expectations of further interest rate increases to contain inflationary pressures.

Bundesbank President Joachim Nagel late on Tuesday said that oil prices are becoming an increasingly important indicator for ECB policymakers in setting interest rates.

Nagel also kept the door open to further interest rate hikes, noting that core inflation is still too high, but added that so far he did not see any significant second-round inflation effects.

Traders this week have slightly pared back their expectations for further rate hikes from the ECB. They were last pricing in around 32 bps of additional tightening this year - so one further hike with a small chance of a second - down from around 40 bps on Friday.

The yield on the German 2-year bond, which is more sensitive to interest rate expectations, was last down a touch at 3.203%.