Key Takeaways
- Eurozone government bond yields are at multiyear highs amid expectations of further interest rate hikes by the ECB.
- The rise in euro government bond yields means higher coupon payments to investors, changing the calculus for those holding bonds for a regular income.
- Government bond yields have not all moved at the same pace, with French OAT and German bunds more sensitive than peripheral bonds such as those of Italy and Spain.
While concerns about rising inflation, growing government deficits and central bank rate increases have sent bond prices lower, the resulting higher yields are offering investors attractive levels of income across much of Europe, analysts and money managers say.
The yield on the 10-year German bund, the benchmark for the eurozone, is above 3.5%, its highest level since 2009. Yields on French government bonds rose to 4.5%, the highest they’ve been since 2008, and the Italian BTP’s yield increased to a two-year high at 4.4%.
Higher yields make borrowing more expensive for governments, companies and individuals. But they also mean more income from coupon payments for investors that can help offset possible losses should bond prices continue to decline.
“Higher yields offer investors a more attractive entry point, with greater income potential and a larger cushion against future market volatility,” says Suparna Sampath, fixed income investment product specialist at Vanguard Europe.
However, within the eurozone, government bond yields have not all moved at the same pace, with French OAT and German bunds being more sensitive than Italian and Spanish peripheral bonds due to the differing trajectories of their public finances.
Why Are Eurozone Government Bond Yields Rising?
A range of factors are pushing bond yields higher, including high oil prices caused by the war in Iran, which are keeping inflation well above the European Central Bank’s 2% target. Inflation concerns led the ECB to raise interest rates by a quarter point this month. Bond markets are priced for another quarter point hike by the end of the year, probably in December, and two more hikes by mid-2027.
Expectations of tighter monetary policy have affected short-term government bonds the most. The yield on the 2-year German government bond rose to 3.2%, its highest level since 2023, after the ECB confirmed its restrictive policy in its Sept. 10 meeting. Short-term bonds are usually more sensitive to monetary policy than long-term bonds.
However, yields on eurozone government bonds remain high even for long-term maturities. Over the summer, the global selloff on 30-year government bonds caused their yields to spike to levels last seen during the 2011 euro crisis.
How Can Higher Bond Yields Benefit Investors?
The decline in bond prices may have worried investors who saw the value of the bonds in their portfolios fall. Since the beginning of the year, the Morningstar Eurozone Treasury Bond Index, which measures the performance of investment-grade EUR government bonds with maturities greater than one year, has fallen 3.9%.
“Watching yields grind higher can be a difficult process, but higher yields may ultimately benefit investors through greater potential income generation”, say Marc Seidner, CIO of Non-traditional Strategies, and Pramol Dhawan, head of EM portfolio management at Pimco.
“Today’s yields only appear unusually high relative to the artificially suppressed rates of the post—global financial crisis era,” they add.
Following the European sovereign debt crisis, the ECB kept interest rates extremely low and implemented extraordinary monetary measures to support the economy. Between August 2012 and August 2022, the ECB’s key policy rate ranged between 0% and -0.5%.
The current environment is completely different from that of 2022, when yields were initially too low to offset the decline in government bond prices, against the backdrop of the ECB quickly raising interest rates. “Today, attractive inflation-adjusted starting yields may provide ample income to offset price declines related to recent market moves, and broader bond market performance remains resilient”, Seidner and Dhawan say.
They find current yield levels “increasingly appealing by historical standards, offering a compelling entry point for long-term investors.”
Higher interest rates make bond investments more attractive. However, Nicolò Bragazza, associate portfolio manager at Morningstar Wealth, warns that “the pursuit of higher income must always be balanced against the higher volatility that typically goes hand in hand with higher yields.”
Where Should Bond Investors Look for the Best Income Opportunities in the Eurozone?
Along with the rise in yields, a widening gap is emerging within the eurozone between government bonds from continental Europe and those from Southern Europe, driven largely by differences in public finances. Yields in France and Germany have risen more sharply than in Italy and Spain. The 10-year bund yield has risen 29.8% over the past year, while the yield on the Italian BTP with the same maturity has risen by 27.6% according to data from FactSet. The French 10-year OAT yield rose by 28.6% during the same period.
Germany’s government deficit is set to increase to 3.7% of GDP in 2026 and 4.1% in 2027, according to European Commission forecasts. Meanwhile for France, the deficit is expected to creep up to 5.7% of GDP. In Italy and Spain, budget deficits are projected to remain between 2% and 3% for 2027.
The spread between bund and OAT yields, which measure the additional return investors demand to hold French debt instead of safer German debt, has widened by about 40% since the beginning of the year to 0.98 percentage points, higher than that of southern European countries—once considered the riskiest—including Italy at 0.88 percentage points and Greece at 0.75 percentage points.
“Peripheral government bonds offer additional income over bunds, though dispersion in valuations and idiosyncratic risks means selectivity is key,” says Vanguard’s Sampath. She encourages investors to consider the risk-adjusted view, rather than pure income. “French spreads have been widening on recent political noise, making it one of the more higher-income regions, though investors question whether the political risks are sufficiently compensated for.”
“Conversely Greece, which in absolute terms now offers less income than France, is on an improving trajectory and there is a view that spreads are over-pricing the risks,” according to Sampath.
Karin Kunrath, chief investment officer at Raiffeisen Capital Management, is bullish on German and French government bonds. “We have had to accept a widening of spreads on French government bonds, but from our perspective, a further significant widening seems unlikely, despite the challenges facing the French government’s budget.”
