Euro area government bond yields edge up, oil prices and Fed in focus

By Stefano Rebaudo

June 16 (Reuters) - Euro area government bond yields pared their rise on Monday, as inflation fears faded after oil prices stabilised, with investors 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.

Oil prices edged down on Monday, however, as renewed military strikes left oil production and export facilities unaffected.

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

German 10-year Bund yields DE10YT=RR rose one basis point (bps) to 2.54%, after hitting a week-high at 2.588%. They marked a low of 2.422% on Friday, the lowest since March 3.

Yields on the two-year Schatz DE2YT=RR were flat at 1.86%.

"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 for 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 depo rate at 1.78% EURESTECBM4X5=ICAP by December, from 1.75% early in the session. They also indicate an around 50% chance of an ECB easing move in September EURESTECBM2X3=ICAP. The depo rate is currently at 2.0%.

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 would 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.

BofA expects the Fed to remain comfortably in wait-and-see mode.

Italy's 10-year government bond yield IT10YT=RR dropped 0.5 bps at 3.49%, with the spread between Italian and German yields at 94.50 bps. It hit 84.20 bps last week, its tightest since March 2015.