(Updates prices)

By Stefano Rebaudo

July 27 (Reuters) - Government bond yields across the euro

zone fell on Monday as easing oil prices helped soothe

short-term inflation fears following U.S. President Donald

Trump's decision to suspend attacks on Iran.

Oil prices tumbled 9.5% after the U.S. and Iran paused

strikes over the weekend, raising hopes of a diplomatic solution

that would de-escalate the conflict and allow shipping to resume

in the Strait of Hormuz.

Germany's two-year yields, more sensitive to

expectations for policy rates, fell 4.3 basis points to 2.777%,

after reaching a two-year high of 2.8938% last week.

Money markets slightly scaled back bets on European Central

Bank rate hikes, pricing a deposit rate of 2.68% in December

and 2.73% in February 2027 from the current

2.25%. Last week, they fully priced a depo rate at 2.75%.

The ECB still considers the current inflation shock to be

medium-sized, which requires some policy action but not

aggressive moves, and it will get price growth back to 2% in the

next year or so, ECB chief economist Philip Lane said.

The central bank kept interest rates unchanged as expected

on Thursday but held the door open to another increase in

September.

Germany's 10-year government bond yield, the

euro zone's benchmark, was down 5 bps at 3.124%. It reached

3.2118% last week, its highest since May 2011.

German business morale grew more than forecast in July on a

significant improvement in expectations, a survey showed on

Monday.

"A packed agenda with high-profile data cluster on Thursday

and several central bank decisions could add to the relief and

also decisively shape the direction for yields, curves and

spreads for the rest of the summer," said Commerzbank strategist

Rainer Guntermann, mentioning upcoming U.S. inflation figures

due after the Federal Reserve's policy meeting.

Investors will closely watch the Fed meeting for signals on

how Chair Kevin Warsh views energy-driven risks.

A growing chorus of policymakers recently argued rates may

need to rise, setting up a charged debate at the Fed, though

markets are still betting rates will stay on hold.

Traders are pricing in a 33.7% chance of a hike, according

to CME Group's FedWatch Tool, up from 12% roughly two weeks

ago.

Markets do not expect any action on rates from either the

Bank of Japan or the Bank of England on Thursday.

Italy's 10-year government bond yields fell 6

bps to 3.942%.

The spread between Italian government bonds and Bunds

was at 79 bps. It stood at 63 bps in February

before the attack on Iran, and hit 103.62 in late March, the

highest level since June 2025.