Benchmark European bonds on track for worst weekly selloff since March as energy prices soar

Adds U.S. data, updates pricing

By Amanda Cooper

LONDON, Sept 11 (Reuters) - Euro zone government bond prices steadied on Friday, as the global debt market headed for one of its worst weekly performances since the start of the Iran war, battered by surging energy prices that are forcing central banks to act quickly to combat inflation.

The European Central Bank on Thursday increased euro zone rates by a quarter point, as expected, while raising its forecast for inflation and cutting its growth projection.

Expectations for a rate hike from the Federal Reserve next week ramped up on Friday after data showed that U.S. consumer prices accelerated in August. The Bank of Japan meets next week as well and is also widely expected to lift borrowing costs.

At one point on Friday, bond yields across the Group of Seven biggest economies were headed for their biggest weekly rise since the start of the war in late February. Two-year yields are being hit particularly hard, as investors have rushed to price in a growing chance that policymakers from Tokyo to Washington and Ottawa will lift borrowing costs to ward off a damaging spike in inflation.

Attacks by U.S. and Iranian forces on targets, including tankers, around the Gulf have fanned fears of the conflict widening across the Middle East, while energy shipments through the Strait of Hormuz have slowed to a handful and producers such as Saudi Arabia are starting to cut production.

German 2-year bond yields DE2YT=RR were little changed on Friday at 3.19%, having traded around 3 bps higher earlier in the day. They have risen more than 25 bps this week, the most since the first week of the war in early March.

"The week is ending on a chaotic, confusing and very uncertain note, with escalating tensions in the Red Sea seemingly tipping the balance for oil prices, and inflation risks, as the conflicts in the Persian Gulf and Black Sea show no sign of easing," Marc Ostwald, chief economist and global strategist at ADM Investor Services, said.

"The spillover into interest rate markets is becoming more acute."

Benchmark 10-year Bund yields have risen almost 18 bps this week, also the biggest weekly rise since the start of March. They were last 1.7 bps higher on the day to 3.5136%. U.S. 10-year Treasury yields, meanwhile, came close to touching 5% for the first time since October 2023, a high previously hit in 2007.

SHORT-DATED BONDS HIT HARD

Short-dated bonds have been hit hard this week, but policymakers and investors are keenly watching long-dated yields, which reflect investor confidence in governments' long-term finances.

ECB President Christine Lagarde said Thursday's rate hike was a "no-brainer", and warned that the return of inflation to its 2% target, now seen at the end of 2027, could be delayed even further.

Money markets show traders think the ECB will raise rates at least three more times by the middle of next year.

Two-year Italian bonds IT2YT=RR, which have been the worst performers among the G7 this week, with a rise of 29 bps, jumped in price, which sent yields down 2.6 bps to 3.41%. Italian 10-year debt last yielded 4.37%, little changed on the day.

French bonds gained some respite, but still edged higher amid an increasingly complex fiscal picture, leaving 2-year yields FR2YT=RR 1.7 bps higher on the day at 3.404%, up around 28 bps this week.

Finance Minister Roland Lescure said on Friday that France's economy would grow less than expected this year and the government would miss its budget deficit target.

(Reporting by Amanda Cooper, additional reporting by Sophie Kiderlin; Editing by Joe Bavier and Alex Richardson)