(Updates throughout)

By Sophie Kiderlin

LONDON, May 12 (Reuters) - Euro zone bond yields climbed

on Tuesday and markets were pricing in three interest rate rises

by the European Central Bank this year as hopes faded for a

peace deal in the Iran war.

U.S. President Donald Trump said the ceasefire with Iran was

"on life support" after Tehran rejected a U.S. proposal to end

the conflict and stuck to a list of demands that Trump has

described as "garbage".

"Clearly there has been a lot of back and forth gyrations

that we've had over the last few weeks when it seemed there was

no hope, then there was a lot of hope, then we're back to little

hope. So it's very hard to know what the final endpoint is,"

Sandra Horsfield, economist at Investec, said.

Germany's 2-year yield, which is regarded as more

sensitive to rate expectations, was 5.1 basis points higher at

2.6971%.

Interest rate expectations picked up again on Tuesday, with

money markets pricing in around three 25-basis-point interest

rate hikes from the ECB by the end of the year. The probability

of a policy increase in June was last at close to 90%.

ECB policymaker Joachim Nagel said on Tuesday the ECB must

raise interest rates if the oil shock resulting from the Iran

war threatens to unmoor inflation expectations in the euro zone.

"Should the effects prove large or persistent, and

especially if they threaten to de-anchor long-term inflation

expectations, our mandate requires us to act," Nagel, the head

of Germany's Bundesbank, told a central bank event.

Andrzej Szczepaniak, senior European economist at Nomura,

said it was almost guaranteed that inflation expectations will

rise further, thus opening the door for the ECB to raise rates

at its June meeting.

The central bank will try to get ahead of so-called

second-round inflation effects like a wage-price spiral, he

said.

"Basically, the ECB will be saying by raising rates once or

twice, hey, look, we're not going to leave inflation or

inflation expectations unchecked. We're going to make sure we

get ahead of things and ensure that inflation stabilizes at

target over the medium term," Szczepaniak said.

The yield on the German 10-year bond, the

benchmark for the euro zone, was 4.3 bps higher at 3.0863%.

Italy's 10-year bond yield jumped 7.4 bps to

3.8559%.

The German federal statistics office on Tuesday said that

EU-harmonised inflation stood at 2.9% in April, confirming

preliminary figures.