Government borrowing costs are climbing sharply across Europe and the United States, as fading hopes for a quick end to the Iran conflict push oil prices higher and reignite inflation fears. On Tuesday, long-term bond yields in several major European economies hit multi-year highs, with France's 10-year yield touching its highest level since 2009 and Germany's benchmark Bund yield reaching its strongest since 2011.
The sell-off in government bonds was driven by a combination of geopolitical risk and supply concerns. International benchmark Brent crude traded near $91 a barrel on Tuesday morning, as tensions in the Middle East showed no sign of easing. The breakdown in US-Iran peace talks has increased the risk that energy prices remain elevated for the rest of the year, which could keep inflation higher than expected and increase the chance of central banks raising rates, said Richard Carter, head of fixed interest research at Quilter Cheviot.
Markets price in tighter ECB policy
Investors are increasingly betting on tighter monetary policy in the eurozone. According to Trading Economics, the market now sees a 90% probability of a September rate hike by the European Central Bank. The ECB deposit rate is expected to reach 2.76% by March 2027, up from 2.25% currently.
In the United States, the 30-year Treasury yield rose to 5.33%, a level not seen since 2007. In the UK, the 30-year gilt traded at 5.85%, its highest level since May 2026. These moves reflect a global repricing of interest rate expectations and inflation risk.
France's 10-year bond yield climbed to 4.10% on Tuesday morning, its highest since June 2009. Germany's 10-year Bund yield, the benchmark for the eurozone, rose above 3.25%, reaching its highest level since March 2011. France's 30-year yield also hit its highest since 2008, while Germany's 30-year yield reached 3.78%, a 15-year peak.
The rise in long-dated yields is not solely a story of inflation and rate expectations. Investors are also concerned about the scale of borrowing in major economies including the UK, France and Japan, Carter noted. Significant volumes of AI-related bond issuance have added to supply, creating further pressure on prices and pushing yields higher.
Higher borrowing costs ripple through economies
Higher bond yields translate into increased financing costs for governments, businesses, and households. As government debt offices constantly raise money through bond markets, the effect of the jump in yields will gradually feed into their borrowing costs as they refinance maturing debt.
Italy is expected to refinance maturing debt equivalent to 17% of GDP in 2026, according to S&P Global Ratings, compared with 12% for France and 7% each for Germany and the UK. This makes southern European economies particularly vulnerable to sustained yield increases.
For now, bond markets are likely to remain sensitive to developments in both geopolitics and economic data, Carter said. The situation in the Middle East, particularly around the Strait of Hormuz, remains a key risk factor for energy prices and inflation.
The broader fiscal picture in Europe is also under scrutiny. France's 2027 budget negotiations and next year's presidential election are adding to investor unease about the country's debt trajectory. Meanwhile, Sweden's next government is set to harden its EU budget stance, which could complicate efforts to coordinate fiscal policy across the bloc.
As the ECB navigates this environment, its decisions will have significant implications for the eurozone economy. The EU carbon market, which affects energy prices, is also under fire from various quarters, adding another layer of complexity to the inflation outlook.
With bond markets on edge, investors are bracing for a period of higher volatility and potentially sustained upward pressure on yields across the continent.
