Citi argued that the ECB's monetary policy would be into "properly restrictive territory" if the central bank's depo rate rose above 2.5%, from the current 2.25%.
"A stalemate between those two constituencies (ECB doves and hawks) means we see a reasonably high probability that the ECB does not hike rates during the remainder of this year," Citi said.
Germany's 10-year bond yield DE10YT=RR reached 3.44%, its highest level since 2011, and was last up 8.1 basis points (bps) on the day.
"The combination of elevated oil prices, drought-related food inflation concerns and lingering uncertainty around gas supply risks continues to support the market's risk premium," said Evelyne Gomez-Liechti, multi-asset strategist at Mizuho.
She said the ECB's policy decision this week could be a potential "turnaround point" if ECB President Christine Lagarde avoids any clear rate-hike forward guidance.
German two-year bond yields, more sensitive to policy rates, were last up about 7 bps to 3.05%, near a more than two-year high.
Money markets pointed to an ECB deposit rate of 2.75% by the end of the year, implying traders are fully pricing in an additional rate hike after the widely expected increase on Thursday.
A Reuters poll of 65 economists on September 3 had suggested the ECB would raise rates on Thursday for a second time this year and then end what would be its shortest hiking campaign in 15 years.
"The ECB began tightening relatively early, and the combination of higher bond yields and elevated energy costs should weigh on European growth in the near term, giving policymakers scope to remain on hold," said David Zahn, head of European fixed income at Franklin Templeton.
"The next move in ECB rates after Thursday may be to cut rates in late 2027," he added.
Euro zone yields rise ahead of ECB meeting
Euro zone government bond yields reached fresh multi-year highs on Wednesday before the European Central Bank's meeting as traders priced in two interest rate hikes in 2026 and a 3.1% rate by late 2027.
The ECB, which raised rates in June, is widely expected to tighten its policy again at the end of its latest meeting on Thursday, while reiterating its data-dependent stance as the Iran war drags on.
Energy prices and inflation concerns support yields
Investors are closely watching Brent crude futures, which rose above $100 a barrel, as well as European natural gas prices, which hit a fresh 3-1/2-year high TRNLTTFMc1, and the so-called crack spread — the margin between refined products and crude oil.
Refinery costs have risen sharply since late June, fuelling inflation.
Several merchant vessels in the northern Gulf and Gulf of Oman were hit by disabling attacks during military activity in the region overnight.
Peripheral bond yields and U.S. buyback add pressure
Italy's 10-year government bond yields rose close to 10 bps to 4.29%.
France's 10-year OAT yields FR10YT=RR hit a fresh 18-year high at 4.33%, up nearly 11 bps, as concerns about the country's fiscal trajectory weighed on sentiment.
Yields were also pushed higher later in the day as the U.S. Treasury Department said it will buy up to $6 billion in 10- to 20-year Treasury bonds during its buyback operation on Thursday, triple the size of its last long-dated operation.
TLT•
