(Updates throughout)

By Sophie Kiderlin and Stefano Rebaudo

March 23 (Reuters) - Euro zone government bonds rallied

in a bumpy session on Monday after President Donald Trump said

he would order the U.S. military to postpone any strikes against

Iranian power plants and energy infrastructure for five days.

Trump said he has had "good and productive conversations"

with Iran.

Meanwhile, Iran's Tasnim news agency, citing an Iranian

official, said that the Strait of Hormuz would not return to

pre-war conditions and energy markets would remain unsettled,

adding that no negotiations with the U.S. were underway.

Bonds had been selling off for the fourth consecutive

session earlier in the day, but then sharply reversed course

following Trump's comments. Over the weekend, Trump

had threatened to destroy Iranian power plants if Tehran failed

to "fully open" the Strait of Hormuz to all shipping within 48

hours.

"What's done is still not undone, so the impact has yet to

be seen. But obviously markets are breathing a sigh of relief on

this news," Chris Beauchamp, chief market analyst at IG Markets,

said.

Germany's 10-year government bond yield, the

euro area's benchmark, was last down around 5 bps at 2.9873%,

after hitting 3.077% early in the session, its highest since

June 2011.

The spread between German and Italian 10-year bond yields on

Monday had widened as far as 103.62 bps for the first time since

June 2025, but was last back down to around 86 bps.

"I think we are literally trading off of headlines now,"

Andrzej Szczepaniak, senior European economist at Nomura, said,

noting that most economic data being published was already

stale.

"From a market perspective it's really just monitoring the

news headlines that we're getting over the course of today and

this week, seeing how those impact oil and gas headlines and

obviously from that perspective, yields."

SHIFTING RATE EXPECTATIONS

Global bonds have been under pressure as the conflict in the

Middle East has stoked inflation fears, with central banks

around the world last week raising the alarm on the risk of

higher prices. The accelerating inflation concerns have also

upended central bank policy expectations.

Those shifted again on Monday after Trump's remarks, with

investors scaling back their bets on future European Central

Bank rate hikes.

Money market pricing last indicated an around 61%

probability of an ECB rate hike at its next meeting in April,

down from close to 90% earlier in the day. Markets were last

pricing in at least two rate increases from the ECB this year,

compared with at least three previously.

This is, however, still a sharp contrast from the end of

February, when the ECB was broadly expected to keep rates steady

this year.

ECB policymaker Peter Kazimir on Monday said that the

central bank would not hesitate to tighten policy if the coming

energy-driven inflation surge looks like it could become

entrenched.

Shorter-dated bond yields, which are more sensitive to

policy expectations, also broadly turned lower, with German

2-year yields last down close to 10 bps to 2.5716%. They had

risen as high as 2.764% earlier in the day.

Italian 2-year yields were 7.8 bps lower to

2.8813%, having climbed to 3.151% previously.