LONDON, April 1 (Reuters) - Euro zone government bond

yields edged lower on Wednesday as investors remained cautious

over the conflict in the Middle East, even after U.S. President

Donald Trump suggested the war could be nearing an end.

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

was down 0.5 basis points (bps) to 3.0%. It hit 2.932% in early

trading, its lowest since March 18.

Germany's rate-sensitive two-year yield fell one bp to 2.60%

, and traders also reduced the amount of European

Central Bank rate hikes they expect this year.

They are pricing in a European Central Bank depo rate at

2.68% -- which implies two hikes and an around 70% chance of a

third tightening move -- from 2.73% late Tuesday.

The deposit facility rate is currently at

2%.

The United States will end its war on Iran fairly soon and

could return for "spot hits" if needed, President Trump told

Reuters on Wednesday.

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 3 bps

at 3.88%.

Still, analysts cautioned Wednesday'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 fall in yields comes 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.