Euro zone yields rise for the week as ECB rate hike bets increase

Updates prices

By Amanda Cooper

LONDON, July 17 (Reuters) - Euro zone government bond yields rose this week alongside oil prices, as renewed hostilities in the Middle East prompted investors to wager the European Central Bank will deliver more than one additional rate hike this year.

Oil prices jumped 13% this week, partly reversing the declines of recent weeks and briefly hitting one-month highs above $86 a barrel LCOc1, as U.S.-Iran clashes in the Gulf effectively closed the Strait of Hormuz.

A flurry of cooler U.S. inflation readings helped U.S. Treasuries outperform the global bond market this week. Two-year Treasury yields US2YT=RR fell by the most in a month, dropping 6 basis points to 4.14% on Friday.

Given the European economy's greater vulnerability to imported energy, euro zone bonds have come under pressure.

Investors now see the ECB raising rates at least once more in September and attach a roughly 72% chance of a second hike before the end of the year. A week ago, they expected just one hike.

Still, economists believe two more hikes on top of June's are unlikely and some think a number of the big central banks, including the Federal Reserve and the Bank of England, will not raise rates again this year.

"As oil prices remain elevated, we could get more hawkish comments from the central banks. Our view still remains that we should not see any hike from the Fed, BoE or the ECB this year," Jefferies strategist Mohit Kumar said.

Two-year German Schatz yields DE2YT=RR rose 10 basis points this week and were trading at 2.77%, up 1 bp on the day.

That maturity is the most sensitive to changes in rate or inflation expectations. The premium the U.S. government must pay to borrow for two years over that of the German government has fallen to around 136 bps, its narrowest in two months DE2US2=RR.

"While oil prices still remain well below their latest highs, the damage at the front-end seems to be done," said Commerzbank strategist Hauke Siemssen.

Two-year Italian bonds IT2YT=RR performed the worst this week, with yields rising 15.3 bps to 2.99%, given that Italy relies more heavily on imported fuels than many of its neighbours.

Benchmark 10-year German Bunds DE10YT=RR have fared similarly poorly. The yield rose nearly 8.5 bps this week to around 3.12%, almost matching the weekly increase in 10-year French bond yields FR10YT=RR, but trailing the 14-bps increase in Italian BTP yields IT10YT=RR.

(Reporting by Amanda Cooper; Editing by Alexandra Hudson, Andrei Khalip, Colin Barr and Joe Bavier)