Euro zone bonds rally as oil softens; focus on Fed view on rates

* Euro zone bond yields fall for third day as prices rally strongly

* Energy price surge and impact on inflation in focus

* ECB and Fed expected to maintain current monetary policies (Updates throughout with comments, prices)

By Amanda Cooper

LONDON, March 18 (Reuters) - Euro zone government bonds headed for their biggest three-day rally since last October on Wednesday, helped by a softening in oil prices, and a degree of caution ahead of a Federal Reserve interest rate decision that could offer some insight into how global policymakers view the inflation outlook.

German 10-year Bund yields were last down 2.3 basis points at 2.888%, bringing their decline over the last three days to nearly 10 basis points, the most since last October, as prices have risen.

Bund yields, a benchmark for the wider euro zone, are still up by nearly 20 bps since the U.S.-Israeli war on Iran ignited a surge in energy prices that has prompted investors to consider the possibility that interest rates might soon rise, which damages the appeal of fixed income assets.

Two-year yields have risen by over 30 bps this month. They were last flat at 2.382%.

AWAITING WORD FROM POWELL

Natural gas prices eased, while oil prices stabilised around $100 a barrel on Wednesday, but are up by around 40% since the start of the war, as marine traffic that carries roughly 20% of the world's daily energy supplies through a choke-point controlled by Iran has been mostly cut off.

The Fed is not expected to announce any changes to monetary policy, but what Chair Jerome Powell says about another repeat of the energy shock that followed Russia's invasion of Ukraine in early 2022 could set the tone for the ECB, which meets on Thursday.

The ECB is also not expected to make any changes to policy. So traders will be looking for any sign from ECB President Christine Lagarde about how justified current market pricing is for two possible rate rises this year and what parallels the head of the central bank might see with 2022.

2022 VERSUS TODAY

"I thought it was quite interesting that (Lagarde) has highlighted how oil and gas prices were a lot more elevated at the time (in 2022), compared to where we are now," Camille de Courcel, who is head of developed market rates and strategy for Europe at BNP Paribas Markets 360, said.

"...it does give a perception that they are in no rush to hike. But she also said they will do whatever it takes to keep inflation under control, which clearly suggests that if they need to act, indeed they will, and it will be a hike."

Lagarde said last week the ECB will do "everything necessary" to keep inflation under control to avoid the inflation surge of 2022 and 2023. She has also reiterated the ECB is "in a good place", something de Courcel said might not feature in policymakers' post-decision comments.

"We think they are going to drop that line," she said, adding that markets broadly expected the same and that retaining that reference might see some of the hikes that are currently priced in for 2026 unwind.

On the data front, a final read of harmonised euro zone inflation for February showed the core rate, which excludes food, energy, alcohol and tobacco, rose 2.4% last month, in line with expectations.

Italian 10-year yields, which have risen 36 bps this month, were down 2 bps at 3.64%, while French 10-year yields were down 3.5 bps at 3.525%. (Reporting by Amanda Cooper; Editing by Bernadette Baum and Ros Russell)