July 20 (Reuters) - German two-year government bond yields

were roughly unchanged after rising to a two-year high early on

Monday amid expectations that the European Central Bank will

deliver two additional rate hikes by early 2027.

Euro area borrowing costs tracked moves in oil prices which

pared their early rise and were last down 0.15% at $88 per

barrel, after Iran's foreign ministry said negotiations with the

U.S. could be pursued based on national interests.

Germany's 2-year yields, more sensitive to

expectations for policy rates, were flat at 2.78%, after

reaching 2.8174%, their highest level since July 2024.

Money markets indicated the ECB deposit rate at 2.67% in

December and 2.75% in February 2027

, from the current 2.25%. They also fully

priced a rate hike in September.

Analysts flagged that the tight correlation between oil

prices and the euro front-end, a dynamic that dominated market

moves throughout March, April and May, has resurfaced in recent

trading.

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

area's benchmark, was up 1 basis point at 3.13%. It reached

3.20% in mid-May, its highest level since May 2011.

Market participants continued to expect the ECB to leave

interest rates unchanged at its policy meeting later this week.

"Despite the resurfacing tensions in the Middle East and

rising oil prices, these remain somewhat below the June baseline

assumptions and signs of second-round effects remain limited,"

said Giada Giani, an economist at Citi.

Euro zone firms expect selling prices to rise more moderately

and see a slowdown in wage growth, an ECB survey showed on

Monday, adding to evidence that a recent energy-driven inflation

surge has yet to generate second-round price impacts.

"Crude oil prices are still well below the spring highs but

refined products prices tell a different story as diesel and

gasoline are trading like if oil was at $110/120," Societe

Generale said.

"For the ECB, a saving grace is that this still mostly an

oil story and not a gas/electricity one though prices are

creeping higher there too."

Italy's 10-year government bond yields rose 1.5 bps

to 3.96%.

The yield gap between Italian government bonds and bunds

was at 80 bps. It was at 63 bps in February before

the attack on Iran and hit 103.62 in late March, the widest

since June 2025.