European Union and UK negotiators are closing in on a draft Brexit deal, which could be published on Wednesday morning, according to news reports from Bloomberg and the Guardian.
German 10-year government bond yields rose to 2.5 month highs, up as much as 5 basis points on the day, with a sharp sell-off taking place following news of the potential draft deal.
Money markets scaled back expectations of a rate cut, to as low as a 10% chance of a 10 bps rate cut from the European Central Bank in December, down from a 20 bps probability on Friday.
A key gauge of long-term inflation expectations reached three-week highs at 1.21% as a deal would ease economic uncertainty.
Safe-haven German government bonds are extending losses after a heavy sell-off last week, when the 10-year yield went up 15 bps on optimism over Brexit and prospects for a US-China trade deal, which eased uncertainty about the global economic outlook.
Irish bonds continued to benefit from progress on Brexit talks, with the gap between the 10-year bond yield and its German peer falling to its lowest level since July, at 43 bps.
"It's potentially removing one of the key risks that has been out there," said Commerzbank rates strategist Rainer Guntermann. "There are certainly some remaining issues and this implies the risk on trend could continue if all this is confirmed on the UK side, in parliament," he added.
The EU's chief Brexit negotiator Michel Barnier is expected to brief EU governments on the progress of a potential deal on Wednesday.
"We are watching the Irish spread. It hit a low in July and then the worries about a no-deal Brexit meant the spread widened," said Daniel Lenz, a rates strategist at DZ Bank.