(Updates with afternoon trading)

By Stefano Rebaudo

June 25 (Reuters) - Euro zone government bond yields

rose on Wednesday as investors processed concerns about

increased fiscal spending across the euro area and kept a wary

eye on the Iran-Israel ceasefire.

Germany's cabinet approved a draft budget with record

investments on Tuesday, while on Wednesday, NATO leaders

endorsed a higher defence spending goal of 5% of GDP by 2035.

German 10-year government bond yields, which

serve as the benchmark for the wider euro zone, rose 3 basis

points (bps) to 2.56%.

Yields on 30-year German bonds hit a near one

month high of 3.087%.

Analysts expect rising bond supply across the euro area from

more fiscal spending to drive long-term yields higher.

Though at least in the case of defense spending, the

processes for raising funds, whether at a national or European

wide level, remain uncertain.

"Market participants remain skeptical about Europe's

ability to materially increase defence spending in the short

term," said analysts at Goldman Sachs in a note.

Also in the mix were closely watched oil prices, which

held near multi-week lows on the prospect that crude flows would

not be disrupted, after a ceasefire between Iran and Israel.

Trump said that the intelligence following the strikes on

Iranian nuclear sites was inconclusive, but also suggested the

damage could have been severe.

Analysts argued that a spike in energy prices could lead to

higher inflation and cause markets to scale back their bets on

central bank rate cuts.

Analysts at Societe Generale said it could have pushed

European headline inflation to 3.5% year on year, but the

de-escalation had largely removed that risk.

"Now, the outlook moves back to the fundamentals that

point to further disinflation, driven by softer energy prices, a

stronger euro, and weakening wage pressures. Together, these

factors should push headline inflation down to 1.5% year-on-year

by end-2025," they said.

Money markets priced in a European Central Bank deposit

facility rate at 1.75% in December, a level

seen before the Israeli attack against Iran on June 13, after a

rise up to 1.80% on Monday.

A key market gauge of euro area long-term inflation

expectations was last 2.12% from 2.08% on June 12.

A decline in risk appetite recently widened the yield

spreads between government bonds of highly indebted countries

and safe-haven German Bunds, before risk sentiment improved and

spreads narrowed again.

The Italian yield gap versus Bunds -

a market gauge of the risk premium investors demand to hold

Italian debt - was at 94 bps. It widened up to 104 bps last

week, while being below 90 bps on June 12.

Italy's 10-year yields rose 2 bps to 3.51%.

The French gap versus Bunds was at

69 bps after reaching 75 bps last week. It was at 65 bps in

early June.