(Updates all prices)

By Alun John and Lucy Raitano

LONDON, May 5 (Reuters) - Euro zone government bond

yields were a touch lower on Tuesday, in line with softer oil

prices, following a sharp selloff on the previous day, with

investors focused on developments in the Strait of Hormuz.

Germany's 10-year bond yield, the benchmark for the euro zone,

was down 1 basis point at 3.075%, after a 5-bp jump in the

previous session.

Its rate-sensitive two-year yield was down 3 bps at 2.6911%,

just off last week's one-month high of 2.76%.

Traders are closely tracking the situation in the Gulf as

they assess whether central banks will be forced to raise

interest rates to prevent higher energy prices from spilling

over into broader inflation, and if so when.

U.S. Defense Secretary Pete Hegseth said on Tuesday the

ceasefire with Iran was not over, even as the U.S. and Iran

exchanged fire in the Gulf and wrestled for control of the

Strait of Hormuz.

The European Central Bank kept rates unchanged last week,

but debated a hike and signalled that policy tightening might be

necessary in June.

Bond yields rose sharply on Monday, driven by a jump in oil

prices. As oil edged lower on Tuesday, yields fell.

Government bond markets have sharply diverged from global

stock markets. While equities, led by the U.S. and tech-heavy

Asian bourses, are higher than their pre-war levels, yields,

which move inversely to bond prices, remain well above their

levels from late February.

Before the conflict, Germany's 10-year yield was at 2.65%

and its two-year at 2.00%.

The difference between stocks and government bonds suggests

"markets are treating the most likely outcome as a mild

stagflationary shock, enough to constrain central banks, but not

enough to pose more serious long-term risks," Lotfi Karoui,

multi-asset credit strategist at PIMCO, said in a note.

"Put another way, risk assets appear to be more willing to

look through a period of potentially softer growth, higher

inflation, and constrained monetary policy, while rates can't."

Other euro zone yields moved largely in line with the German

benchmark.

Italy's 10-year yield fell 5 bps to 3.8867% and its two-year was

down 1 bp at 2.8865%.

Markets see Italian debt as more vulnerable than German. When

yields have risen with oil prices, the gap between Italian and

German debt has widened. It was last at 78 bps, 5 bps narrower

on the day. It widened by 3 bps on Monday.