(Updates with afternoon trading)

By Stefano Rebaudo

April 24 (Reuters) - Euro zone short-dated government

bond yields were set for their biggest weekly rise in more than

a month as tensions over the Strait of Hormuz spurred energy

prices higher, stoking inflation fears and European Central Bank

rate hike expectations.

Friday's news flow offered some support to bonds, with Iran's

Foreign Minister Abbas Araqchi expected in Islamabad, venue for

past peace talks with the United States, raising hope that

negotiations could resume.

But the collapse of the talks earlier in the week, and the

Strait of Hormuz remaining broadly closed left Brent crude

futures at about $105 a barrel, well up on the week, and markets

pricing at least two European Central Bank rate hikes this year,

and around a 40% chance of a third.

Last week, optimism about a negotiated end to the conflict

meant markets were not fully pricing two ECB rate hikes.

Germany's two-year yields, sensitive to

expectations for monetary policy rates, were little changed on

Friday at 2.56% but set for a weekly increase of 13 bps, their

most since mid-March.

The euro zone benchmark, the 10-year German yield, was also

flat on the day at 3.01%.

Both had been trading higher earlier in the day, but dipped as

markets saw some signs of optimism about the weekend talks, a

move that extended further after U.S. Attorney Jeanine Pirro

said the Justice Department is closing its investigation into

cost overruns in renovations at the Federal Reserve under

Chairman Jerome Powell.

The decision removes an obstacle to the confirmation of

Kevin Warsh, President Donald Trump's pick to lead the central

bank.

The ECB meets next week, and while it is expected to keep rates

on hold, it is widely expected to place a stronger emphasis on

bringing inflation under control, even if doing so comes at the

expense of short-term economic growth.

Underscoring their dilemma, data on Friday showed German

business morale fell more than expected in April, as the

U.S.-Israeli war with Iran made companies more pessimistic and

threatened the long-awaited recovery of Europe's biggest

economy.

"The war in the Middle East and soaring energy prices have

again exposed the fact that Germany is one of Europe's largest

net importers of energy," said Carsten Brzeski, global head of

macro at ING.

"With the war in the Middle East now gradually shifting from

a pure energy price shock towards an energy supply and broader

supply chain shock, the German economy is once again at the

centre of an exogenous, global, disruption."

Other euro zone yields were largely moving in line with

Germany's on Friday.

Italy's 10-year government bond yields IT10YT=RR rose 1 basis

point to 3.81%. The yield gap of Italian government bonds versus

Bunds DE10IT10=RR was at 76 bps, having earlier hit 78 bps, its

highest level since April 8, the day after the U.S.-Iran

ceasefire announcement.

(Reporting by Stefano Rebaudo; additional reporting by Alun

John; Editing by Emelia Sithole-Matarise)