Sovereign debt – The risk of rising rates

Inflation and interest rate expectations drive yields

Yields on European government bonds have risen steadily in recent years. In the last three years alone, yields on 10-year German government bonds and comparable French government bonds have climbed by more than one percentage point. As a result, the French yield recently broke through the 4% mark for the first time since 2008. At first glance, this development is surprising. After all, since 2024, the European Central Bank has significantly lowered its key interest rates, which are crucial for the bond markets.

However, this factor is more than offset by other aspects: Governments continue to issue debt and the ECB has stopped its bond purchases. This increases the supply of government bonds, lowers the demand and requires higher interest rates to attract investors. In addition, the war in Iran has put noticeable pressure on the bond market because energy prices – and thus inflation – in Europe have risen again. Furthermore, financial markets expect central banks to (further) raise their key interest rates in response to rising inflation. While financial markets had anticipated two Fed rate cuts earlier this year, they are now pricing in at least one rate hike by the end of the year

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