LONDON, March 25 (Reuters) - Euro zone bond yields fell

on Wednesday, led by a recovery in Italian bonds which have been

among the hardest hit since the start of the Iran war, as

falling oil prices boosted risk appetite among traders.

Germany's 10-year Bund yield - the euro zone

benchmark - was last down 6.4 basis points at 2.95%, while

Italy's 10-year yield was down 10.4 bps at 3.83%.

Italian bond yields have surged nearly 60 bps since the U.S.

and Israel launched airstrikes on Iran on February 28, compared

with a rise of about 32 bps for Bunds. Italy is more dependent

on imports of fossil fuels than many of its neighbours.

"I would pin it on general risk appetite ... every higher

beta in FX and bonds (are) outperforming this morning including

Italy and Greece," said Kenneth Broux, head of corporate

research FX and rates at Societe Generale.

He said the moves showed logical price action, with traders

buying back lagging assets first. "This may be all short-lived

if peace talks do not take place or go nowhere."

Israel and Iran exchanged airstrikes on Wednesday, as Iran's

military rejected President Donald Trump's assertion the U.S.

was in negotiations to end the war that has roiled energy and

financial markets, saying the U.S. was negotiating with itself.

It followed reports overnight that the U.S. sent Iran a

15-point plan aimed at ending the war, according to a source.

Oil prices softened, with Brent crude futures

dropping 5.3% to around $98.8 a barrel, while Europe's benchmark

STOXX 600 rose 1.7%.

Traders were also digesting a survey showing German business

morale fell in March, although by less than expected.

Germany's 2-year Schatz yield - the most sensitive to

expectations for interest rates and inflation - fell 4.5 bps to

2.6%.

Elsewhere, European Central Bank President Christine Lagarde

said even a "not-too-persistent" overshoot of the central bank's

inflation target from the current energy shock may warrant some

moderate policy tightening.

Markets are pricing a 65% chance of a 25 bps rate hike at

the ECB's next meeting. Rate-hike bets mark a stark shift

from before the war, when expectations leaned towards a cut this

year.