Updates all prices, adds inflation news, adds analyst quote

By Lucy Raitano

LONDON, May 29 (Reuters) - Euro zone bond yields steadied on Friday as investors assessed mixed inflation figures from the bloc's major economies while awaiting more details of a potential deal to reopen the Strait of Hormuz and extend the U.S.-Iran ceasefire.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the bloc, was steady at 2.9587%. It has fallen 7 basis points this month, as investors grew more optimistic about a potential Iran peace deal, in turn bringing oil prices down and tempering bets on European Central Bank rate hikes.

The two-year German bond yield DE2YT=RR - more sensitive to ECB interest rate expectations - was unchanged at 2.559%. Yields move inversely to prices.

Italian bond yields fell by more, with the 10-year yield IT10YT=RR down 2.3 bps and the 2-year yield IT2YT=RR down 2 bps.

Inflation in the euro zone's four largest economies hovered above the ECB's 2% target for a third straight month in May, preliminary data showed on Friday, as a rise in fuel costs triggered by the Iran war began to feed through to other prices.

Country-specific figures were mixed. While German figures were cooler than expected, the Spanish reading was hotter-than-expected, as was Italy's. In France, inflation came in below the forecast but crept higher month-on-month.

The United States and Iran reached an agreement on Thursday to extend their ceasefire and lift restrictions on shipping through the Strait of Hormuz, sources told Reuters, though U.S. President Donald Trump has yet to approve it and Iranian state media said it had not been finalised.

Oil fell 1.8% to $92 a barrel LCOC1.

"In terms of market reactions if a deal is agreed upon, we should see another leg higher in risky assets and lower in rates. However, positioning suggests that the rates market should see a greater reaction than equities," wrote Mohit Kumar, chief European economist at Jefferies.

INFLATION JITTERS KEEP OPTIMISM IN CHECK

Kenneth Broux, head of corporate research for FX and rates at Societe Generale, said euro zone bonds have been underperforming U.S. recently.

"Europe as a whole is definitely underperforming the U.S. after outperforming through May, I wonder how much of the lower oil price and short-covering in Bunds is priced in. Support for the 10-year Bund at 2.90% is a hurdle too far for now at least," he said.

With the Strait of Hormuz still largely closed and the global flow of energy disrupted, fears of rising inflation in the import-dependent euro zone had led traders to ramp up bets on central bank rate hikes in recent weeks.

The worries subsided as optimism grew around a peace deal. But key data reads are keeping inflation fears at the forefront.

Friday's euro zone CPI figures come a day after figures showed U.S. inflation increased at its fastest pace in three years in April, cementing economists' views that the Federal Reserve would hold interest rates unchanged well into ​next year.

Also out on Friday was data showing France's economy shrank slightly in the first quarter, missing the preliminary reading of 0.0% for the euro zone's second-largest economy.

European Central Bank research showed on Friday that euro zone consumers, already scarred by the Ukraine war, have changed their attitudes more quickly as a result of the upheaval of the Iran conflict, meaning the economic hit could be deeper and faster.

"Today’s inflation data are further cementing the case for a rate hike," said Rabobank analysts in a note, as they also flagged a pick-up in consumers' medium-term inflation expectations.

"However, we still believe that the current backdrop is less conducive to broader and protracted inflationary pressures than 2021-2022."

Money markets are betting on a 91% chance of a rate hike at the ECB's next meeting on June 11. IRPR

"For the ECB, we can see one hike (in June), simply because they have to justify their inflation credibility. However, we do not see a series of rate hikes and maintain our long position at the front end of the curve," said Jefferies' Kumar.