LONDON: Investors took refuge in German bonds on Thursday after Saudi Arabia launched air strikes in Yemen but analysts said a further fall in yields was capped by the prospect of an inflation-boosting oil price rise.
Saudi Arabia and Gulf region allies launched military operations in Yemen on Thursday, officials said, to counter Iran-allied forces besieging the southern city of Aden where the U.S.-backed Yemeni president had taken refuge.
Yemen's slide towards civil war has made it a crucial front in mostly Sunni Saudi Arabia's rivalry with Shi'ite Iran, and stoked fears that Middle East fighting was spreading out of control.
Global investors headed for German bonds, the euro zone's top-rated debt, while news of the conflict also sent the price of oil surging up 6 percent.
"The impact of Saudi Arabia's air strikes in Yemen is complex," said Mizuho strategist Peter Chatwell.
"It's geo-political risk, so Bund bullish, but the rise in the oil price should push expectations of headline inflation higher over the coming months."
German 10-year yields opened a touch lower on Thursday at 0.22 percent, heading back towards record lows of 0.165 percent. All other euro zone yields were flat or 1-2 basis points higher.
Analysts said the sharp rise in oil prices, closely watched by central banks to gauge inflation expectations, was preventing yields on top-rated debt from falling further as investors cut exposure to risky assets.
Yields on other so called safe haven bonds in the U.S. and Japan were broadly unchanged while global stock markets fell.
One-year forward inflation rates in the euro zone were up 6 basis points to 0.37 percent, having hit a two-week high of 0.39 percent in early trading.
The euro zone will report preliminary flash inflation data next week, which Commerzbank strategists said on Thursday should bolster expectations it is fending off a deflationary spiral.
"Next week's flash HICP should further underpin the positive sentiment, with the core rate in particular expected to remain above the all-time low recorded in January," said Commerzbank.
Yields on low-rated Italian and Spanish bonds rose 2 bps to 1.36 and 1.30 percent, respectively.
That did not hinder Italy's 3.5 billion euro auction of bonds linked to euro zone inflation (BTPEIs) and zero coupon bonds (CTZs).
A fraught situation in Greece is also keeping investors cautious, however, with Athens preparing to deliver reforms to unblock bailout funding.
Greece's economy minister said on Thursday he was optimistic about reaching a deal on economic reforms with its euro zone peers early next week.
Greek 10-year yields rose 7 bps to 11.07 percent.
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