Euro zone yields fall on hopes Iran war could end soon

By Alun John

LONDON, April 1 (Reuters) - Euro zone bond yields dropped on Wednesday after U.S. President Donald Trump said the end of the war on Iran could be near, a development that would ease traders' fears about high energy prices driving inflation and interest rate hikes.

Germany's 10-year yield, the benchmark for the euro zone, dropped to a two-week low of 2.93% in early trading and was last at 2.96%, still down 5 basis points.

Germany's rate-sensitive two-year yield also fell 5 bps to 2.57%, and traders also reduced the amount of European Central Bank rate hikes they expect this year - they are pricing in two 25-bp rate hikes, and see a third as a toss-up, compared with earlier in the week when they thought three hikes were near certain. 0#EURIRPR, DE2YT=RR

"We'll be leaving very soon," Trump told reporters at the White House on Tuesday, saying the exit could take place "within two weeks, maybe two weeks, maybe three."

The remarks underscored the shifting and at times contradictory timelines and statements from Washington about how and when the war, now in its fifth week, might end, and attacks took place on multiple fronts early on Wednesday.

But the comments, alongside a planned address by Trump to the nation scheduled for 9 p.m. EDT on Wednesday (0100 GMT on Thursday) were enough to drive some optimism across stock and bond markets. European shares rose 2% and were set for their biggest daily gain in nearly a year.

Italian debt, which has underperformed in recent weeks on the view the country is more exposed to higher energy prices, outperformed on Wednesday.

Italy's 10-year yield was down nearly 9 bps at 3.82%. IT10YT=RR

But analysts cautioned Tuesday's rally was fragile.

"Markets will want to see whether this leads to a path toward de-escalation. The question that remains is how quickly energy flow can be fully restored, given the destruction already incurred," analysts at ING said in a note.

The falls in yields come after dramatic rises in March, as traders bet a surge in energy prices could drive a broader move in inflation and in turn interest rate hikes by the ECB, and most of its global peers.

Germany's two-year yield rose 60 bps in March, its most in a month since 2022, and its 10-year increased by 36 bps.

Italy's two-year yield surged 76 bps in the month, and its 10-year jumped 63 bps.

Reinforcing those worries about inflation, PMI data from Wednesday showed euro zone manufacturers faced soaring input costs and supply chain disruptions in March.

ECB policymaker Primoz Dolenc said the euro zone economy may already be on the "adverse" path outlined by the ECB, and inflation could become entrenched quicker than in 2022 as memories of rapid price rises shape consumer behaviour.

Dolenc is the latest in a string of policymakers to give similar warnings, but ING noted markets had tended not to react to their comments, after they had already priced in significant hikes this year.

"At least pricing (for ECB rate hikes) has not become more pronounced despite some of the latest ECB commentary coming in on the hawkish side," they said.