European short-dated government bonds advanced, recovering from the prior session's steep selloff as traders pared back expectations of aggressive interest rate increases across the region.

The yield on Germany's two-year Schatz declined 4 basis points to 3.20%, pulling back from Thursday's peak of 3.24%—the highest level in nearly three years. In contrast, longer-dated German yields moved higher, with the 30-year bond yield climbing 2 basis points to 3.90%, resulting in a steeper yield curve. Elevated energy prices have once again intensified inflation concerns, driving bond yields upward. German bunds are on track for their worst weekly performance since the onset of the US-Iran conflict.

Swap markets now fully price in three additional rate hikes by the European Central Bank through June of next year, following Thursday's increase. Related wagers have eased somewhat after a sharp build-up the day before.

In the UK, the two-year gilt yield fell as much as 10 basis points to 4.67%, a notable retreat from Thursday's 4.87%—the highest since October 2023. Market data showed Germany's 10-year yield rising 1 basis point to 3.52%, while bund futures slipped 4 ticks to 120. Italy's 10-year yield edged down 1 basis point to 4.35%, narrowing the spread over German bunds by 3 basis points to 85 basis points. France's 10-year yield gained 3 basis points to 4.47%, and the 10-year UK gilt yield decreased 3 basis points to 5.35%.