* Oil surges 9% as Iran conflict worsens

* European and Asia stock markets tumble, borrowing costs

rise

* ECB and BoE next up in packed 24 hours of central bank

meetings

(Updates with European market moves)

By Marc Jones and Ankur Banerjee

LONDON/SINGAPORE, March 19 (Reuters) - European markets

fell sharply on Thursday as the latest escalation in the U.S.

and Israel's war with Iran sent oil prices soaring again and

left top central banks grappling with when and how to handle the

likely jump in inflation.

Attacks on Iran's South Pars gas field, on the world's

largest gas plant in Qatar and on oil refineries in both Saudi

Arabia and Kuwait sent Brent prices shooting to $115 a barrel

, consigning the FTSEurofirst 300 to a near 2%

early drop.

Benchmark government bond yields - which set the global cost

of borrowing - also rose as rate decisions from both the

European Central Bank and Bank of England loomed after the Bank

of Japan and the U.S. Federal Reserve both aired their concerns

about the conflict.

Traders expect the ECB will have to deliver at least two

rate hikes this year, from having priced around a 40% chance of

a cut in 2026 prior to the war erupting.

Switzerland's central bank has already said it was keeping

rates at zero, but signalled its readiness to intervene to curb

the recent surge in the Swiss franc as investors look for

traditional pockets of safety.

"Central banks are looking at this situation cautiously,"

said FIM Partners' CIO of emerging market debt Francesc

Balcells.

"I don't think they want to overreact (to the spike in

energy prices), but they don't want to make the same mistakes of

the past either," he said, referring to 2022 when central banks

mistakenly judged the post-COVID, post-Ukraine invasion surge in

inflation to be temporary.

The ratcheting up of the war also sent Europe's natural gas

prices surging 25% to their highest levels of the

crisis so far.

U.S. President Donald Trump said an angry Israel had "violently

lashed out" when it attacked Iran's major gas field on

Wednesday. Iran then retaliated by firing missiles at gas and

oil facilities in Qatar, Saudi Arabia and Kuwait.

In the currency markets, the yen remained near the key

160 per dollar level as the BOJ left its interest rates

unchanged. It left traders on watch for possible FX intervention

after strong comments from Japanese Finance Minister Satsuki

Katayama earlier in the day.

WORLD STOCKS DROP

The Nikkei and South Korean equities both

dropped around 3% overnight, while MSCI's broadest index of

world shares fell another 0.8% to its lowest

level of the year so far.

"This latest escalation feels like a turning point for

markets because the conflict is no longer just about military

headlines or Strait of Hormuz closure," said Charu Chanana,

chief investment strategist at Saxo in Singapore.

"It is now hitting the plumbing of the global energy system.

What is unsettling markets now is the growing stagflation

risk... It means this is no longer just a geopolitical story but

a macro one."

The dollar strengthened across the board, also buoyed by the

Federal Reserve predicting just one more cut this year as the

central bank left rates unchanged on Wednesday. Traders though

are no longer fully pricing in any easing in 2026.

The dollar index, which measures the U.S. currency

against six other units, is up 2.5% since the war broke out at

the end of February as investors look to the greenback as the

haven of choice. The index was last at 100.15, up fractionally

after a 0.7% rise on Wednesday.

The two-year U.S. Treasury yield, which typically

reflects near-term rate expectations, was up roughly 6 basis

points to 3.8%, its highest since August 2025.

ECB AND BOE UP NEXT

In a week filled with policy meetings across the globe,

investors have been parsing comments to gauge the impact of the

war.

The European Central Bank and Bank of England decisions are both

due later in the day. Neither is likely to budge their rates,

but any hints on how the conflict could impact their future

plans will be forensically dissected.

The Bank of Japan left its short-term policy rate at 0.75% as

widely expected overnight, but it joined the U.S. Federal

Reserve and Bank of Canada in striking a cautious tone about the

war and pricing pressures.

The yen was last at 159.71 per dollar, having dropped over

2% against the dollar this month.

Fred Neumann, chief Asia economist at HSBC, said the path

ahead for the BOJ is narrowing, noting rising price pressures

from soaring energy costs and a weaker currency are pointing to

prompt and decisive tightening.

BOJ chief Kazuo Ueda offered few clues on how soon it could

raise rates again in his post-meeting press conference. But he

said its next quarterly review of growth and inflation

forecasts, due in April, will be key.