Euro zone bond yields fall on optimism over Iran ceasefire talks

By Lucy Raitano

LONDON, March 25 (Reuters) - Euro zone bond yields fell on Wednesday, led by a recovery in Italian bonds which have been among the hardest hit since the start of the Iran war, as oil prices fell on signs of progress to end the conflict.

Global bond and equity markets have rebounded this week, receiving another boost on Wednesday after the U.S. sent a 15-point plan to Iran to try to end the three-and-a-half-week conflict that has severely disrupted global energy supplies.

Germany's 10-year Bund yield DE10Y=RR - the euro zone benchmark - was last down 6 basis points at 2.953%, its third straight daily fall. It was heading for its biggest daily drop since October.

Italy's 10-year yield IT10Y=RR was down 9 bps at 3.842%.

Italian bond yields have risen over 55 bps since the U.S. and Israel launched airstrikes on Iran on February 28, compared with a rise of about 30 bps for Bunds. Italy is more reliant on imports of fossil fuels than many of its neighbours.

"I would pin it on general risk appetite ... every higher beta in FX and bonds (are) outperforming including Italy and Greece," said Kenneth Broux, head of corporate research FX and rates at Societe Generale.

He said the moves showed logical price action, with traders buying back lagging assets first. "This may be all short-lived if peace talks do not take place or go nowhere."

Israel and Iran continued to exchange airstrikes on Wednesday, while a senior Iranian official told Reuters that Tehran was still reviewing Washington's proposal but the initial response had been negative.

Oil prices softened, with Brent crude futures LCOc1 dropping 3.5% to around $97 a barrel, while Europe's benchmark STOXX 600 .STOXX rose 1.2%.

INFLATION IMPACT

European Central Bank President Christine Lagarde opened the door to a rate hike if the war were to push inflation above target.

The ECB kept its deposit rate unchanged last week, but warned about rising prices from the war.

Markets are pricing in a 65% chance of a 25 bps rate hike at the ECB's next meeting IRPR. They are also pricing in about 66 basis points of tightening this year, implying at least two quarter-point rate hikes by December.

Those bets mark a stark shift from before the war, when expectations leaned towards a cut this year.

Germany's two-year Schatz yield - the most sensitive to expectations for interest rates and inflation - fell 3 bps to 2.612%.

Traders were also digesting a survey showing German business morale fell in March, although by less than expected.