Bond markets face ‘perfect storm’ as Iran war rattles central banks
Europe’s sovereign bonds are facing “a perfect storm” after new inflation fears sparked by the Iran conflict forced the region’s central banks to signal a new course for interest rates on Thursday, sending yields soaring.
The Bank of England left interest rates unchanged at 3.75% on Thursday, with the European Central Bank also holding steady on borrowing costs, as the economic impact of soaring energy costs hangs over rate-setters.
Yields on 10-Year Gilts, the benchmark for U.K. government debt, rose more than 13 basis points to 4.871% — a new 52-week high on Thursday — before easing. The yield on 2-Year Gilts, which are typically more sensitive to rates decisions, immediately surged 39 basis points in the biggest rise since former Prime Minister Liz Truss’s ‘Mini Budget’ in September 2022. They were last seen 27 basis points higher, at 4.378%.
French, German and Italian bonds saw less severe selling pressure, but yields rose across the continent.
U.K. 10-Year Gilts.
Market strategists say the BoE’s move — a unanimous call by its nine-member monetary policy committee — effectively ends hopes of any further rate cuts this year and dramatically shifts the policy outlook from where it was just two weeks ago.
Tactical trading
Ed Hutchings, head of rates at Aviva Investors, said that the chances of a rate hike from the BoE over the coming months have increased.
“With this in mind, from an asset allocation perspective, we could start to see investors tactically adding overweights in gilts in the short-term, with at least one hike expected later in the year as of today,” Hutchings said.
Matthew Amis, investment director, rates management at Aberdeen Investments, described the unfolding environment as a “perfect storm” for Europe’s sovereign bond markets.
German 10-Year Bunds.
“Energy prices spiking higher and the Bank of England opening the door to potential rate hikes have seen gilts spike higher. German bunds are the relative calm in this storm but are still pushing 3% due to similar inflation fears,” Amis told CNBC via email.
“Gilts and bunds are pricing in a much longer conflict than other markets, focusing on the inflation surge with markets yet to focus on the potential negative impact on growth.”
Meanwhile, the ECB’s next move will now likely be a hike, according to Simon Dangoor, deputy chief investment officer of fixed income and head of fixed income macro strategies at Goldman Sachs Asset Management.
“The governing council is clearly sensitive to upside inflation risks, but will likely look to assess potential second-round effects before making a move,” Dangoor said. “A hike is therefore possible later in 2026; however, the ECB stands ready to act sooner if the situation deteriorates.”
‘An economic Dunkirk’
Energy prices continued their upward advance Thursday, with Brent crude, the international benchmark, hitting $111.10, a 3.5% rise, while natural gas prices also traded higher….
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