Euro Rates Still Bullish Despite Oil Price Increases

The eurozone's economic growth has been expected to continue its upward trend, but recent energy price increases have put pressure on interest rates. Despite oil approaching $100 again, euro rates are still following higher due to the growth picture being important as well.

While US markets were closed for Labor Day, pressure on EUR rates continued to build at the short end due to geopolitical headlines pushing up oil prices. The 2-year Bund yield is back to 3%, nearing the peaks of last week.

The impact of energy prices on euro rates is not evenly distributed across the curve. While 2-year Bund yields have risen 90bp since the start of the year, 10-year yields have only increased around 55bp. Only 30bp of this increase can be attributed to rising inflation expectations.

Disappointing economic performance could trigger a material bullish move in rates. If the eurozone economy fails to deliver on heightened growth expectations, the ECB's reaction function could change quickly, leading to a dovish repricing of near-term policy rate expectations and a pullback in the neutral rate as well.