Traders ramp up European rate hike bets on hawkish cen banks, oil surge

* Traders price in more than two hikes from ECB, BoE

* BoE holds rates but vote more hawkish than expected

* Two-year bond yields surge as investors await ECB (Rewrites throughout after BoE decision)

By Samuel Indyk and Yoruk Bahceli

LONDON, March 19 (Reuters) - Investors doubled down on their bets on central bank rate hikes in Europe on Thursday, betting that surging energy prices would leave central banks there with no choice but to tighten policy as the Iran war escalates.

Oil prices jumped to as high as $119 a barrel on Thursday as Iran attacked energy facilities across the Middle East following Israel's strike on its South Pars gas field, in a major escalation of the war.

The reaction from trading floors was clear with the rate-hike bets put on since the start of the war gaining momentum, with major central banks expected to be more responsive to higher energy prices than they have in the past, especially with the 2022 energy crisis fresh in memory.

The Bank of England vindicated those expectations on Thursday, when policymakers voted unanimously to keep rates on hold and some raised the prospect of raising rates.

That was a surprise to markets, with economists polled by Reuters mostly expecting a 7-2 vote in favour of a hold decision.

Traders now bet the BoE will raise rates twice this year and see a chance of a third hike by year-end. They had been pricing in less than a full chance of two hikes before the decision. Highlighting the turnaround in markets, they had expected a rate cut at this meeting before the war.

"It felt as though markets were positioned for a relatively brief price shock rather than an extended crisis. If we do get prices going higher and staying higher for longer, then it makes sense that the broader washout in markets would be more painful," said Schroders head of global economics David Rees.

"It's pretty clear from the communication from the Bank of England today that all options are on the table until you get the evidence," Rees added, expecting a similar tone from the European Central Bank, which releases its interest rate decision at 1315 GMT.

Traders' ECB rate-hike bets have also jumped and they now fully price in two rate hikes and more than a 50% chance of a third move by December. That's a stark turnaround from before the war, when the risk was a cut this year.

The escalation in the war topped by a hawkish tone from central banks added to the pain in financial markets on Thursday.

Two-year bond yields, sensitive to interest rate expectations, surged across the world and jumped over 30 basis points (bps) in the UK, setting them for their biggest daily increase since former Prime Minister Liz Truss's failed economic plan in 2022.

Across the euro zone and the United States they were about 15 bps higher .

The U.S. Federal Reserve kickstarted a hawkish turn from central banks on Wednesday, prompting traders to all but fold on their bets on a rate cut this year.

(Reporting by Samuel Indyk and Yoruk Bahceli; editing by Dhara Ranasinghe, Alexandra Hudson and Andrew Heavens)