(Updates after morning trading)

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.

"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%.

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.