* Oil surges 9% as Iran conflict worsens

* European and Asian stock markets tumble, borrowing

costs rise

* BoE and ECB hold rates in back-to-back central bank

meetings

(Updates after Bank of England and ECB hold interest rates

steady)

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

and consigned the FTSEurofirst 300 to a 2%

drop.

Benchmark government bond yields - which set the global cost

of borrowing - also rose as the Bank of England's rate setters

voted unanimously to keep UK rates on hold due to the widespread

uncertainty. The European Central Bank held its rates as well,

warning that the Iran war was clouding the outlook for growth

and inflation, after the Bank of Japan and the U.S. Federal

Reserve had both aired their concerns about the conflict too.

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 kept its rates at zero earlier,

but it signalled it was ready to intervene to curb the recent

surge in the Swiss franc, one of the traditional pockets of

safety during market turmoil.

The unanimity to hold at the BoE underscored the nervousness

further. Before the Iran crisis, economists thought it might

have been limbering up for a rate cut at this point.

"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 as much as 25% to their highest

levels of the crisis so far. Wall Street futures though

were pointing lower again, with the S&P 500, Dow Jones and

Nasdaq down between 2% and 5.5% this month.

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 responded 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 edged up 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 FLAGS ENERGY PRICE RISK

In a week filled with policy meetings across the globe,

investors have been parsing comments to gauge the impact of the

war.

The ECB said the Iran war would "have a material impact on

near-term inflation through higher energy prices", adding: "Its

medium-term implications will depend both on the intensity and

duration of the conflict and on how energy prices affect

consumer prices and the economy."

The Bank of Japan had 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.