Euro zone government bonds tumbled and the euro edged higher on Monday after hawkish comments from European Central Bank officials, while European stocks tracked Asian markets higher.
Oil prices rose from last week's 6-month low having experienced their steepest slump in more than a decade due to robust winter fuel stocks and easing geopolitical and weather risks to supplies.
Over the weekend during the G7/IMF meeting in Singapore, ECB officials reinforced expectations for higher interest rates, stressing economic strength and inflation risks. As a result, financial markets are now pricing in around an 85 percent chance of rates rising to 3.75 percent by mid-2007.
ECB officials appear to be preparing the market for a probability of interest rates rising beyond 3.50 percent, said Wee-Khoon Chong, strategist at Bank of America.
People in the market are gradually hardening a view that rates might go to 3.75 percent by June.
The December Bund contract was down 50 ticks at 117.00 . The euro was up 0.2 percent on the day at $1.2658 and up 0.7 percent against a broadly weaker yen at 149.6.
ECB Chief Economist Juergen Stark said growth was very healthy and the job market was picking up while ECB Governing Council member Mario Draghi said interest rates in the euro zone were still extraordinarily low and that spare capacity was running out.
On Monday their Austrian colleague Klaus Liebscher added to the hawkish campaign, saying he saw rising danger of rising inflation as risks to the 2007 outlook.
The yen hit a five-month low of 118.23 yen and fell broadly after the weekend G7 meeting did not mention the yen weakness in its communique, although some members called for the yen to appreciate.
For those hoping for some JPY relief from the G7 get-together this weekend, the statement was a disappointment... the G7 has failed to enliven the structural debate, leaving the JPY exposed, Calyon said in a note to clients.
Investors are focused on the release of the U.S. second-quarter current account data and July capital flows data due later in the session.
STOCKS, OIL UP
European stocks ticked higher, with the FTSEurofirst 300 up a third of a percent at 1,377.74 point.
Scania jumped more than 5 percent after the Swedish truck maker and major shareholder, Investor, rejected an offer from MAN .
Swedish markets were higher after an election win by an alliance headed by Moderate Party leader Fredrik Reinfeldt, which had vowed to cut taxes, trim back the welfare state to boost jobs, and sell government stakes in the firms.
Shares in telecoms firm TeliaSonera , bank Nordea and airline SAS all rose 2 to 3 percent.
The broad share index was up 0.9 percent.
The Swedish crown rose to a one-month high of 9.1592 per euro.
Tokyo markets were closed for a national holiday. The rest of Asian stocks staged their best performance in two weeks, with MSCI's broadest index of Asian shares ex-Japan rose more than one percent.
U.S. stock futures were pointing to a firmer start on Wall Street later.
Oil prices were slightly higher on the day, with NYMEX crude for October delivery at $63.42 a barrel.
Gold prices took a sharp climb up after last week's hefty sell-off, rising by almost $5 an ounce.
Gold has lost around 20 percent of its value since hitting a 26-year high of $730 in mid-May, when investors poured money into the market as a hedge against Middle East tensions and inflationary concerns linked to rising oil prices.
Silver also rose more than 2 percent.