June 4 (Reuters) - Euro zone government bond yields were

mixed on Thursday as investors weighed a flare-up in violence in

the Middle East against a new ceasefire agreement between Israel

and Lebanon.

While the agreement between Israel and Lebanon to implement a

new ceasefire raised hopes for progress toward ending the wider

U.S.-Israeli war with Iran, there were still few signs of

progress towards reopening the Strait of Hormuz, a step which

would be expected to ease energy-driven inflationary pressures

and dampen expectations for further central bank rate hikes.

Germany's 2-year yields, more sensitive to

expectations for policy rates, were down 3 basis points at

2.64%. They reached 2.771% in late March, the highest since July

2024.

"The air for even higher yields is getting thinner in the

absence of bleak headlines that would signal a deterioration (in

the Middle East conflict)," Erik Liem, rate strategist at

Commerzbank, said.

"This leaves technicals as the main driver for today's

session," he added, mentioning auctions in France and Spain.

Germany's 10-year government bond yield, the euro

zone benchmark, was down 2.5 bps at 3.04%. It reached 3.13% in

late March, its highest level since June 2011.

Money markets are pricing the ECB deposit rate at 2.67% by

December, which implies two rate hikes and

about a 65% chance of a third. Markets have almost fully priced

in a rate hike next week and another in September.

ECB POLICY MEETING

Even if most economists expect two tightening moves this year,

some believe that one hike could be enough this year if the

Strait of Hormuz opens gradually during the summer.

"What ECB will do next week is more of a pre-emptive rate

hike," said Pia Fromlet, macroeconomist at SEB.

"After that, there will be more concern about real economic

effects, and together with a gradual reopening of the Strait of

Hormuz, that will make it possible for the ECB to leave the

rates unchanged going further ahead."

Markets will be watching for any hints from the ECB on

second-round inflationary effects, the knock-on responses,

particularly in wages, that can make inflation more persistent

and drive further monetary tightening.

Investors are also looking ahead to the U.S. employment

report on Friday, which could influence the Federal Reserve's

policy path.

Italy's 10-year government bond yields fell 3 bps to

3.75%, with the yield gap versus German Bunds at

73 bps. It was at 63 bps in late February before the first

attacks on Iran and hit 103.62 in late March, the highest level

since June 2025.