Aug 27 (Reuters) - Euro zone government bond yields rose

on Tuesday as investors worried about the risk that geopolitical

tensions in the Middle East could boost inflation expectations,

slowing down the European Central Bank's easing path.

The price of crude oil, one of the main drivers of consumer

prices, dropped after surging more than 7% in the previous three

sessions on supply concerns prompted by fears of widening Middle

East conflict and a shutdown of some Libyan oil fields.

Investors remained cautious before the release of the bloc's

August inflation data later in the week, which could provide

clues about the ECB's monetary policy path.

Germany's 10-year government bond yield, the

benchmark for the euro zone, rose 2.5 basis points (bps) to

2.27%, after hitting 2.276%, its highest since Aug. 8.

Markets also closely watched political developments in

France.

President Emmanuel Macron appeared to be back to square one

in consultations to form a new government as Socialists and

Greens said they would not participate in further talks.

Macron thinks the balance of power lies more with the centre

or centre-right. But any such alliance would also require

driving a wedge through the left to win backing from its more

moderate factions, something leftist leaders have repeatedly

ruled out.

"The default option (without a new government) would mean a

budget drawn up by the caretaker prime minister Gabriel Attal,"

said Edmond de Rothschild Asset Management.

"Ten billion euros in cost-cutting is planned, but that

would be less than expected by Brussels in its excessive deficit

procedure against France."

Parliamentary approval of the 2025 budget is one of many

tests at a time when France is under pressure from the European

Commission and bond markets to reduce its deficit.

RISK PREMIUM

The yield gap between French and German government bonds

- a market gauge of the risk premium investors

demand to hold France's public debt - widened to 72.5 bps. It

hit 88 bps in early August, its highest since 2012, and reached

85 bps during French elections.

Germany's two-year bond yield, more sensitive to

expectations for policy rates, was up 1 bp at 2.40%.

Analysts said the ECB still sounded intent to proceed

cautiously with quarterly cuts. Easing moves in-between meetings

are likely to come into play if data on euro area inflation

falls more abruptly.

Market bets on ECB rate cuts barely moved after the Federal

Reserve policy meeting last Friday and cautious remarks by ECB

officials about the easing cycle during the weekend.

They priced in around 65 bps of rate cuts by year-end

, which implies two rate cuts and a 60%

chance of a third move, not far from the levels seen last week

before the Fed.

They also fully discounted a 25 bps cut and an about 30%

chance of a 50 bps move by the Fed in September.

San Francisco Fed President Mary Daly said late Monday "the

time is upon us" to reduce interest rates, likely starting with

a quarter-percentage point.

Italy's 10-year yield, the benchmark for the

euro area periphery, was up 6 bps at 3.65%, and the gap between

Italian and German bunds widened to 137 bps.