European bond markets hit by “perfect storm” as inflation fears rise

Europe’s sovereign bond markets have come under mounting pressure as renewed inflation fears linked to the Iran conflict push central banks toward a more cautious—and potentially tighter—monetary stance, sending yields sharply higher across the region.

The European Central Bank held interest rates steady at its March 19 policy meeting, but warned that the war has made the economic outlook “significantly more uncertain.” 

Policymakers highlighted growing risks tied to both inflation and growth, noting that the conflict has introduced “upside risks for inflation and downside risks for economic growth,” prompting investors to reassess expectations for future rate cuts.

In its statement, the ECB stressed that the ongoing crisis “will have a material impact on near-term inflation through higher energy prices”, adding that longer-term effects will depend “both on the intensity and duration of the conflict and on how energy prices affect consumer prices and the economy.”

Other major European central banks—including the Bank of England, Sveriges Riksbank, and Swiss National Bank—also opted to leave interest rates unchanged the same day, reflecting widespread uncertainty as the war continues to disrupt global energy markets.

Prior to the outbreak of the US-Iran war in late February, inflation across Europe had been stabilizing, and expectations were building that borrowing costs might remain steady or even decline. However, the surge in energy prices has reversed that trend, raising concerns about persistent inflation and weakening growth prospects.

Recent data from Eurostat showed eurozone inflation ticking up to 1.9% in February from 1.7% in January, still near the ECB’s 2% target but now trending higher. The central bank has since revised its medium-term projections upward, expecting inflation to average 2.6% in 2026, 2% in 2027, and 2.1% in 2028—largely due to rising energy costs.

Bond markets have reacted strongly to this shift. In the UK, yields on 10-year government bonds climbed to a 52-week high of 4.871% before easing slightly, while two-year yields surged sharply in their biggest jump since the 2022 market turmoil following the “Mini Budget.” Across continental Europe, borrowing costs also increased, with French, German, and Italian bonds all experiencing upward pressure, albeit less dramatically.

Matthew Amis of Aberdeen Investments described the current situation as a “perfect storm” for sovereign debt markets, speaking to CNBC.

“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,” he said.

He added that markets appear to be pricing in a prolonged conflict, with a strong focus on inflation risks rather than the potential drag on economic growth: “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.”

Analysts at Goldman Sachs Asset Management suggest that the ECB may ultimately be forced to tighten policy if inflation pressures persist. Simon Dangoor, the firm’s deputy chief investment officer for fixed income, told the outlet that policymakers are closely monitoring developments before acting.

“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.”

By Nazrin Sadigova