Euro zone bond yields inch lower, Strait of Hormuz in focus

LONDON, May 5 (Reuters) - ​Euro zone ⁠government bond yields were a touch lower on ​Tuesday, in line with softer oil prices, following a sharp selloff the previous day, with investors focused on developments in the ​Strait ‌of Hormuz.

Germany's 10-year bond yield, the benchmark for the euro zone, was down 1 basis point at 3.07%, after a ⁠5-bp jump the previous session.

Its rate-sensitive two-year yield was down ⁠2 bps at 2.69%, just off last ​week's one-month high of 2.76%.

Traders are closely tracking the situation in the Gulf as they assess whether central banks will be forced to raise interest rates to prevent higher energy prices from spilling over into broader inflation, ​and if ‌so when.

The European Central Bank kept rates unchanged last week, but it debated a hike and signalled that policy tightening might be necessary in June.

Bond yields rose sharply on Monday, driven by a jump in oil prices after the U.S. and Iran launched new attacks and wrestled for control of the Strait of ​Hormuz.

But as oil on Tuesday edged back - Brent crude futures were down 0.9% at $113.34 a barrel - yields ‌moved lower in sympathy.

Government bond markets have also sharply diverged from global stock markets. While equities, led by the U.S. and tech-heavy Asian bourses, are higher ‌than their pre-war levels, yields, which move inversely to bond prices, remain well above their levels in late February, when the war began.

Before the conflict, Germany's 10-year yield was at 2.65% and its two-year at 2.00%.

The ​difference between stocks and government bonds suggests "markets are treating the most likely outcome as a mild stagflationary shock, enough to ‌constrain central banks, but not enough to pose more serious long-term risks," said Lotfi Karoui, multi-asset credit strategist at PIMCO, in a note.

"Put another way, risk assets appear to be more willing to look through a period ⁠of potentially ⁠softer growth, higher inflation, and constrained monetary policy, while rates can’t."

Other euro ‌zone yields moved largely in line with the German benchmark.

Italy's 10-year yield was down 2 bps at 3.93% and its two-year was ​down 1 bp at ​2.92%.

Markets see Italian debt as slightly more vulnerable than German and so ‌in recent weeks when yields have risen with oil prices, the gap between Italian and German debt has widened.

That gap was last at 80 bps, 4 bps narrower on the day. It widened by 3 bps on Monday. (Reporting by Alun John. Editing by Jacqueline Wong and Mark Potter)