Euro zone yields head for seventh weekly rise; French bonds lag Italy

By Stefano Rebaudo

Sept 25 (Reuters) - Euro zone government bond yields were on track for their seventh consecutive weekly rise as higher energy prices and increasingly hawkish signals from central banks pushed up expectations for policy rates.

Oil prices fell slightly on Friday — as markets weighed the possibility of a truce between the US and Iran against the bombing of Saudi Arabia by Houthi fighters in Yemen — but were set to end the week up 1.5%.

Euro area benchmark Bund yields were down 0.5 basis points at 3.60% after reaching 3.6114% on Thursday, their highest level since June 2009, while being set for an 8-bp weekly rise.

The German 2-year yield , more sensitive to policy rate expectations, was flat at 3.29%, after hitting 3.3269% the day before, its highest level since September 2023.

French and Italian bonds diverged this week, as French debt remained under pressure while Italian government bonds staged a modest recovery.

Investors ramped up bets on policy rate hikes, raising borrowing costs and prompting questions about debt affordability in the euro area's more heavily indebted economies.

The gap between French and German government bond yields — a market gauge of the risk premium investors demand to hold French debt — was on track for a fourth straight weekly rise, widening by 4 bps after hitting 114.06 bps, its highest level since June 2012. It was at 108 bps on Friday.

Emergency energy relief spending has contributed to a deterioration in France's already strained public finances, pushing its deficit-reduction target out of reach.

The Italian spread was set for a slight weekly 1-bp tightening after hitting 99.90, the widest since March 2026. It was last at 90.50.

"Italy's deficit trend, primary balance and fiscal credibility have all materially improved, lending support to its bonds; France, by contrast, appears increasingly fragile, with its deficit and debt trajectories deteriorating," Ugo Montrucchio, chief investment officer multi-asset at Schroders, said.

MARKETS STILL PRICE 100 BPS OF HIKES BY LATE 2027

Money markets priced the European Central Bank’s deposit rate at 2.86% by December , implying one quarter-point rate hike and a slightly less than 50% chance of a second move. They also saw the policy rate at 3.46% by late 2027, compared with 2.50% currently.

Several economists recently said that markets had gone too far in pricing an ECB hawkish response to inflation pressures, arguing that the energy shock will dampen economic growth and consumer price dynamics.

"An AI slowdown and a prolonged energy shock are potential candidates to an economic slowdown, but this is not our base case," Kevin Thozet, a member of the investment committee at Carmignac, said.

"The broader picture remains that of a slower yet resilient growth environment along with lingering inflationary pressures. An environment favouring a cautious stance on sovereign rates, yet seeking to benefit from mounting discrepancies between market expectations of uniformity and different economic realities," he added.