* Markets relieved after Trump delays strikes, but

caution remains

* Bund yields drop from their highest in almost 15 years

* BofA economist says markets underprice adverse economic

impact of the energy shock

(Recasts throughout)

By Stefano Rebaudo and Sophie Kiderlin

March 23 (Reuters) - Euro area government bond yields

dropped sharply and traders scaled back their bets on future

European Central Bank rate hikes on Monday after U.S. President

Donald Trump said he would delay striking Iran's energy

infrastructure.

Trump said he has had good and productive conversations with

Iran about a complete and total resolution of hostilities in the

Middle East.

Hopes for an end of the Middle East conflict eased inflation

fears and saw investors' bets on ECB rate risesdecline, though

they were still fully pricing two increases by year-end.

Oil prices fell 10% after Trump's remarks, hours ahead of a

deadline that threatened further escalation in the four-week-old

conflict.

Germany's 10-year government bond yield, the

euro area's benchmark, was down 3 bps at 3.01%, after hitting

3.077% early in the session, its highest level since June 2011.

"The impact has yet to be seen. But obviously markets are

breathing a sigh of relief on this news," Chris Beauchamp, chief

market analyst at IG Markets, said.

Money markets priced in a depo rate at 2.50% by June

, from 2.67% earlier in the session, which

implied 2 hikes and about a 65% chance of a third move. The ECB

deposit facility rate is currently at 2%.

"As we face another inflation shock, central banks want to

avoid the criticisms of 2022 that they're too relaxed about

inflation, and we can see how that's informing the response

today," Harry Allen, macro strategist at Deutsche Bank, said.

However, some economists argue that markets may have

overdone expectations of a hawkish response from central banks.

"Markets are certainly pricing an inflation and a

geopolitical shock, with a stronger U.S. dollar and higher rates

across the board," Antonio Gabriel, global economist at BofA,

said.

"In our view, more disruptive scenarios for global growth

may be underpriced, and growth concerns could prevail, tilting

some central banks to look through the shock," he added.

Euro zone consumer confidence fell to its lowest level since

late 2023 this month, offering early evidence of how surging

energy prices may impact the broader economy.

Germany's 2-year government bond yield dropped 8

bps at 2.59%, after reaching 2.764%, its highest since July

2024.

The ECB will not hesitate to tighten policy if the coming

energy-driven inflation surge looks like becoming entrenched,

keeping price growth elevated for an extended period, ECB

policymaker Peter Kazimir said on Monday.

Euro area bond yield spreads versus Bunds tightened after

widening significantly in recent sessions, as higher rates will

weigh on most indebted countries such as Italy and France.

The Italian gap tightened to 84 bps after

hitting 103.60 bps early in the session, the highest since June

2025, while the French one dropped to 68 bps after

hitting 91 bps the highest since July 2012.