By Stefano Rebaudo
Sept 9 (Reuters) - Euro zone government bond yields reached fresh multi-year highs on Wednesday before the European Central Bank meeting as traders priced in two hikes in 2026 and a 3.1% rate by late 2027.
The ECB is widely expected to tighten its policy while reiterating its data-dependent stance as the Iran war drags on.
Investors were closely watching Brent crude futures, which rose above $100, as well as 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 fire during military activity in the region overnight.
ECB RATE PATH IN FOCUS
Citi argued that with the ECB depo rate above 2.5%, from the current 2.25%, monetary policy will be into "properly restrictive territory."
"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."
Germany's 10-year bond yield DE10YT=RR reached the highest since April 2011 at 3.40%, up 4 basis points (bps).
"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 sees "tomorrow’s ECB as the 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 up 5 bps to 3.0323%, the highest since January 2024.
Traders priced in the ECB's deposit rate at 2.74% by December, implying more than a 95% chance of an additional hike after the widely expected increase on Thursday. They also indicated a depo rate at 3.10% in September 2027.
A Reuters poll of 65 economists on September 3 had suggested the ECB would raise interest rates on Thursday for a second time 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.
Italy’s 10-year government bond yields rose 2.5 bps to 4.21%. The yield gap versus safe-haven Bunds was at 80.50 bps.
France's 10-year OAT yields FR10YT=RR hit a fresh 18-year high at 4.2827%, up 6 bps, as concerns about the country's fiscal trajectory weighed on sentiment.
(reporting by Stefano Rebaudo; editing by Andrew Cawthorne)