Euro Zone bond yields rise: Government bond yields in the euro zone increased on Monday, recovering from a sharp decline on Friday. Investors remain wary of potential risks stemming from the escalating conflict in the Middle East, although recent developments have somewhat alleviated immediate concerns.

Iran's retaliatory attack on Israel resulted in no significant damage, and the United States indicated efforts to prevent an all-out war between the two nations.

The 10-year government bond yield, a key benchmark for the euro area, rose by 3 basis points after experiencing an 11.8 basis point drop on Friday, marking its largest daily decline since October 9. Bond prices move inversely to yields.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, noted, "The week is starting on a fraught note, with unease still clouding sentiment. Investors are on alert for retaliatory action following Iran's attack on Israel."

She added, "Fears are brewing that a dangerous new episode of escalating conflict is about to roll. All eyes are on the diplomatic efforts being made to diffuse the situation."

The spread between 10-year Treasury and German bond rates hit a fresh 4.5-year high as yields rose more sharply in the US than in the euro area. This difference reflects market expectations of a more hawkish stance from the Federal Reserve compared to the European Central Bank.

While Fed officials emphasised no immediate need for rate cuts and supported expectations for two Fed moves this year, ECB rate-setters suggested the central bank could ease its monetary policy even if the Fed does not.

Lithuanian ECB policymaker Gediminas Simkus suggested a greater than 50 per cent probability of more than three rate cuts this year. Francois Villeroy de Galhau of the ECB expressed increasing confidence in the bank's ability to combat inflation.

Money markets priced in 87 basis points of ECB rate cuts in 2024, with around a 50 per cent chance of a fourth rate cut this year. This pricing was similar to levels seen last week before the release of stronger-than-expected inflation data.

Derivatives on the rates indicated a 45 basis point cut in 2024, with an 80 per cent chance of a second rate cut this year, up from around 50 per cent the previous week after the release of US data.

"There is a line of thought that if Bund yields experience upward pressure from developments inTreasury bonds (as has been the case recently), financial conditions could be overly tight in the euro zone, and the ECB will have to respond with easier monetary policy," noted Rabobank.

Italy's 10-year yield, the benchmark for the euro area's periphery, rose by 1.5 basis points to 3.76 per cent.

(with Reuters inputs)