Inflation risks keep interest rates high
The ongoing conflict in the Middle East and resulting disruptions in the energy markets are driving up inflation expectations and keeping upward pressure on bond yields high. In the Eurozone, heightened inflation risks and robust growth in economic demand point to another ECB rate hike to 2.5% in September. In the US as well, inflationary pressures - particularly in the services sector - remain too high. We therefore expect the Fed to raise rates in September and anticipate another hike in the first quarter of 2027.
In the bond markets, this has already led to a significant upward shift in yield levels. German and US government bonds are trading at their highest yield levels since the start of the Persian Gulf crisis. In the short term, we see little potential for a sustained recovery in the bond markets, as neither a significant decline in energy prices nor a noticeable economic slowdown is on the horizon. Accordingly, yields are likely to remain elevated for the time being.
In the medium term, however, we expect inflation expectations to ease, provided that energy markets gradually stabilize. As a result, yields on shorterterm bonds in particular should come down somewhat. The potential for falling yields at the long end, on the other hand, appears limited for the time being. High government issuance volumes, extensive investments in AI infrastructure, defense, and the energy transition, as well as continued positive growth prospects, point to a structurally higher interest rate environment. Against this backdrop, while we see price appreciation potential for longer maturities, we expect yields to decline only slowly.
Global bond market: Between investment boom and inflation risks
In addition to short-term inflation risks, structural investment cycles are increasingly shaping the development of bond markets. The global expansion of AI infrastructure is triggering an extraordinary investment boom, particularly in the US, and driving corporate bond issuance. At the same time, spending on defense and the green transition is increasing capital requirements in Europe. Despite a significant increase in issuance volumes, bond markets have so far shown no signs of crowding out or limited absorption capacity. Rather, higher yields currently reflect, above all, a normalization of term premiums, increased inflation risks, and an overall positive growth outlook. The environment therefore points to a structurally higher interest rate level in the medium term than in the years prior to the pandemic
Author

Erste Bank Research Team
Erste Bank
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