LONDON, July 28 (Reuters) - Euro zone bond yields fell for

the third session in a row on Tuesday, as optimism about a

diplomatic resolution to the Iran war and easing oil prices

soothed short-term inflation worries.

Germany's 10-year government bond yield, the

benchmark for the euro zone, was down 1.7 basis points at

3.1099%. Last week, it hit 3.2118%, which was its highest level

since 2011.

A lull in hostilities between the U.S. and Iran continued

after Washington's abrupt suspension of air strikes on Saturday.

President Donald Trump said on Monday the United States was

having "good talks" with Iran and there was a chance of a deal.

Brent crude futures extended declines and were

around 2% lower on Tuesday at $86.58 a barrel.

Higher energy costs have been a key driver of inflation

concerns across the euro zone, especially given the European

economy's vulnerability to imported energy.

Various economic data points for the euro zone are due this

week and could shed further light on the impact of the war on

the economy so far, including a reading of the second-quarter

gross domestic product and a flash estimate of July inflation

figures.

The European Central Bank in June hiked interest rates by 25

basis points in an effort to tame inflationary pressures, but

opted to leave policy unchanged at its July meeting last week.

Yet, policymakers have kept the door open to a potential

interest rate increase in September.

Money markets have meanwhile slightly scaled back their

expectations for further tightening from the ECB in recent days.

However, they were last still pricing in a high chance of a

September rate hike, with the possibility of another increase

later in the year.

Germany's 2-year government bond yield, which is more

sensitive to rate expectations, was down 2.8 basis points on the

day to 2.7541%. It notched a two-year high of 2.8938% last week.

Markets are also focused on central bank action elsewhere

this week, with the Bank of England, Bank of Japan and Federal

Reserve all due to make their latest interest rate decisions.