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

on Wednesday led by Italian bonds, after being harder hit since

the outbreak of the Iran war, as falling oil prices boosted risk

appetite among traders.

The German 10-year Bund yield was last down 5.6

basis points at 2.96%, while Italy's 10-year yield

was down nearly 9 bps at 3.85%.

Italian bonds have been worse-hit, with yields gaining

nearly 60 bps since then, compared with a rise of around 32 bps

for German 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 market moves showed logical price action, with

traders moving to buy 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 which has roiled energy and

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

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

15-point plan aimed at ending the Middle East war, according to

a source.

Oil prices softened, with Brent crude futures

dropping 5% to around $95 a barrel, while the European benchmark

STOXX 600 rallied, rising 1.3%.

Traders are digesting the latest survey on German business

morale which fell in March, although by less than expected.

The German 2-year Schatz yield - the most sensitive to

expectations for interest rates and inflation - fell 5.4 bps to

2.88%.

Elsewhere, on Monday 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.

Market watchers are placing a 63% chance of a 25 bps rate

hike at the ECB's next meeting. Bets on rate hikes mark a stark

turnaround from before the war, when the balance was towards a

cut this year.

(Reporting by Lucy Raitano; Editing by Amanda Cooper and Arun

Koyyur)