Euro zone bond yields inch lower with Strait of Hormuz in focus

LONDON, May ​5 (Reuters) - Euro ⁠zone government bond yields were a touch lower ​on Tuesday, in line with softer oil prices, following a sharp selloff on the previous day, with investors focused on developments ​in ‌the Strait of Hormuz. Germany's 10-year bond yield, the benchmark for the euro zone, was down 1 basis point at ⁠3.075%, after a 5-bp jump in the previous session. Its rate-sensitive ⁠two-year yield was down 3 bps at ​2.6911%, just off last week's one-month high of 2.76%.

Traders are closely tracking the situation in the Gulf as they assess whether central banks will be forced to raise interest rates to prevent higher energy prices from ​spilling over into ‌broader inflation, and if so when.

U.S. Defense Secretary Pete Hegseth said on Tuesday the ceasefire with Iran was not over, even as the U.S. and Iran exchanged fire in the Gulf and wrestled for control of the Strait of Hormuz.

The European Central Bank kept rates unchanged last week, but debated a hike ​and signalled that policy tightening might be necessary in June.

Bond yields rose sharply on Monday, driven by a ‌jump in oil prices. As oil edged lower on Tuesday, yields fell.

Government bond markets have sharply diverged from global stock markets. While equities, led by ‌the U.S. and tech-heavy Asian bourses, are higher than their pre-war levels, yields, which move inversely to bond prices, remain well above their levels from late February.

Before the conflict, Germany's 10-year yield was at 2.65% and ​its two-year at 2.00%.

The difference between stocks and government bonds suggests "markets are treating the most likely outcome as a mild stagflationary ‌shock, enough to constrain central banks, but not enough to pose more serious long-term risks," Lotfi Karoui, multi-asset credit strategist at PIMCO, said in a note.

"Put another way, risk assets appear to be more willing ⁠to look through ⁠a period of potentially softer growth, higher inflation, and constrained monetary policy, ‌while rates can't."

Other euro zone yields moved largely in line with the German benchmark. Italy's 10-year yield fell 5 bps to 3.8867% ​and its two-year was down ​1 bp at 2.8865%. Markets see Italian debt as more vulnerable than ‌German. When yields have risen with oil prices, the gap between Italian and German debt has widened. It was last at 78 bps, 5 bps narrower on the day. It widened by 3 bps on Monday. (Reporting by Alun John. Editing by Jacqueline Wong, Mark Potter and Paul Simao)