(Updates prices)

By Stefano Rebaudo

June 16 (Reuters) - Euro area government bond yields

edged lower on Monday, as inflation fears faded after oil prices

stabilised, with investors awaiting the Federal Reserve's policy

meeting later this week.

Iranian missiles struck Israel overnight, fuelling concerns

among world leaders at this week's G7 meeting that the battle

between the two old enemies could escalate into a broader

regional conflict.

Oil prices edged down on Monday, however, as renewed

military strikes left oil production and export facilities

unaffected.

Analysts said a rise in oil prices would fuel inflation, but

there were also downside risks for the economy.

German 10-year Bund yields dipped by 1 basis

point to 2.529% in afternoon trading in Europe, having held in a

narrow range throughout the day. Last week, 10-year yields hit

their lowest since early March at 2.422%.

Yields on the two-year Schatz were marginally

lower at 1.84%.

"Our base case is that the current escalation could last for

a few weeks but should overall remain contained and not spread

into a wider conflict," said Mohit Kumar, chief economist for

Europe at Jefferies.

"Our bias for oil prices remains between $60 and $80. If we

remain in that range, beyond near-term spikes, our overall macro

picture would remain unchanged," he added, arguing that a rise

to $100 would lead to a revision of Jefferies macro views.

Money markets priced in a European Central Bank depo rate at

1.78% by December, from 1.75% early in the

session. They also indicate an around 50% chance of an ECB

easing move in September. The depo rate is

currently at 2.0%.

ECB official remarks underline inflation risks and the need

for the central bank to remain vigilant.

The ECB should keep all of its options open for future

policy moves amid exceptional uncertainty, Bundesbank President

Joachim Nagel said on Monday.

Analysts argued the central bank is keen on stopping rate

cuts to avoid being in a world with limited policy room.

The ECB would pay more attention to the side effects of easy

money in the future, the ECB's Vice-President Luis de Guindos

told Reuters.

Monetary policy decisions from the Bank of Japan and the

Bank of England are also top of the agenda this week.

The Fed is expected to hold interest rates steady, with

investors focused on new central bank projections.

Citi said it expected a neutral to hawkish FOMC given the

still-large uncertainty around the path of inflation, especially

with the recent increase in oil prices.

BofA expects the Fed to remain comfortably in wait-and-see

mode.

Italian 10-year government bonds

outperformed Bunds, falling 3.4 bps to 3.466%, leaving their

premium over German debt at 92.45 bps. The spread hit 84.20 bps

last week, its tightest since March 2015.

;))