Euro zone yields rise, inflationary impact of oil prices in focus

By Stefano Rebaudo

June 16 (Reuters) - Euro zone government bond yields rose on Monday as investors focused on the inflationary impact of a rise in oil prices while awaiting the Federal Reserve's policy meeting later this week.

Iranian missiles struck Israel overnight, fuelling concerns among world leaders at this week's G7 meeting that the battle between the two old enemies could escalate into a broader regional conflict.

Analysts said a rise in oil prices will fuel inflation, but there are also downside risks for the economy.

Brent crude futures were volatile on Monday, following a 7% surge on Friday.

German 10-year Bund yields DE10YT=RR rose 4 basis points (bps) to 2.58%, having marked a low of 2.422% on Friday, the lowest since March 3. Yields on the two-year Schatz DE2YT=RR were up 3 bps at 1.89%.

"Our base case is that the current escalation could last for a few weeks but should overall remain contained and not spread into a wider conflict," said Mohit Kumar, chief economist of Europe at Jefferies.

"Our bias for oil prices remains between $60 and $80. If we remain in that range, beyond near-term spikes, our overall macro picture would remain unchanged," he added, arguing that a rise to $100 would lead to a revision of Jefferies macro views.

Money markets priced in a European Central Bank deposit facility rate at 1.79% EURESTECBM4X5=ICAP by December from 1.75% early in the session. They also indicate a 50% chance of an ECB easing move in September EURESTECBM2X3=ICAP from 60%.

ECB official remarks underline inflation risks and the need for the central bank to remain vigilant.

The ECB should keep all of its options open for future policy moves amid exceptional uncertainty, Bundesbank President Joachim Nagel said on Monday.

Analysts argued the central bank is keen on stopping rate cuts to avoid being in a world with limited policy room.

The ECB will pay more attention to the side effects of easy money in the future, the ECB's Vice-President Luis de Guindos told Reuters.

Monetary policy decisions from the Bank of Japan and the Bank of England are also top of the agenda this week.

The Fed is expected to hold interest rates steady, with investors focused on new central bank projections.

Citi said it expected a neutral to hawkish FOMC given the still-large uncertainty around the path of inflation, especially with the recent increase in oil prices.

Italy's 10-year bond yield IT10YT=RR was up 4 bps at 3.54%, with the spread between Italian and German yield at 93 bps. It hit 84.20 bps last week, its tightest since March 2015.