Euro zone bond yields edged higher on Wednesday as oil prices climbed, a day after swinging dramatically over renewed hostilities in the Middle East and the release of U.S. inflation data.
Germany's 2-year bond yield DE2YT=RR was last up 3.5 basis points at 2.756%. Yields move inversely to prices.
The yield, which is sensitive to central bank rate expectations, rose as much as 8 bps on Tuesday to a two-year high as oil prices jumped on the U.S.-Iran conflict, before falling sharply after U.S. inflation data came in weaker than expected and ending roughly flat on the day.
ECB rate expectations rise with energy prices
Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone, rose 3 bps to 3.102%.
A jump in oil prices over the last week has seen traders sharply raise their bets on ECB rate hikes this year, but they wound them back in somewhat after the U.S. CPI inflation data.
Money markets were last pricing in 43 bps of further ECB tightening this year, up from 30 bps a week ago but down from a peak of 48 bps on Tuesday.
Data on Tuesday showed headline U.S. inflation slowed more than expected to 3.5% year-on-year in June, down from 4.2% in May, although the fall was largely due to a drop in energy prices which is now under threat.
Middle East tensions keep oil markets volatile
The United States and Iran continued to trade strikes on Tuesday and Wednesday after Iran said it had closed the Strait of Hormuz and the U.S. reimposed a naval blockade of Iranian ports.
Iran's Islamic Revolutionary Guard Corps has threatened to close other export corridors, Iranian media reported, in what analysts said was a possible sign it could use its Houthi allies in Yemen to shut the Bab el-Mandeb gateway to the Red Sea, putting two of the world's most vital energy arteries at risk.
Oil prices rose on Wednesday, with Brent crude LCOc1 up 1% at $85.60 a barrel.
Analysts say oil and gas will drive ECB pricing
Analysts at ING said ECB rate pricing was likely to be mainly driven by oil and gas prices.
"Markets’ European Central Bank pricing can continue to diverge from the Fed’s," the analysts, Michiel Tukker and Benjamin Schroeder, wrote on Wednesday.
"The momentum in U.S. inflation should be downwards, whereas for Europe the peak might not be in sight yet, especially if energy prices continue to drift higher again."
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