GLOBAL MARKETS-Europe tumbles on Iran war as central banks hold rates

* Oil surges 9% as Iran conflict worsens

* European and Asian stock markets tumble, borrowing costs rise

* BoE and ECB hold rates in back-to-back central bank meetings (Updates after Bank of England and ECB hold interest rates steady)

By Marc Jones and Ankur Banerjee

LONDON/SINGAPORE, March 19 (Reuters) - European markets fell sharply on Thursday as the latest escalation in the U.S. and Israel's war with Iran sent oil prices soaring again and left top central banks grappling with when and how to handle the likely jump in inflation.

Attacks on Iran's South Pars gas field, on the world's largest gas plant in Qatar and on oil refineries in both Saudi Arabia and Kuwait sent Brent prices shooting to $115 a barrel and consigned the FTSEurofirst 300 to a 2% drop.

Benchmark government bond yields - which set the global cost of borrowing - also rose as the Bank of England's rate setters voted unanimously to keep UK rates on hold due to the widespread uncertainty. The European Central Bank held its rates as well, warning that the Iran war was clouding the outlook for growth and inflation, after the Bank of Japan and the U.S. Federal Reserve had both aired their concerns about the conflict too.

Traders expect the ECB will have to deliver at least two rate hikes this year, from having priced around a 40% chance of a cut in 2026 prior to the war erupting.

Switzerland's central bank kept its rates at zero earlier, but it signalled it was ready to intervene to curb the recent surge in the Swiss franc, one of the traditional pockets of safety during market turmoil.

The unanimity to hold at the BoE underscored the nervousness further. Before the Iran crisis, economists thought it might have been limbering up for a rate cut at this point.

"Central banks are looking at this situation cautiously," said FIM Partners' CIO of emerging market debt Francesc Balcells.

"I don't think they want to overreact (to the spike in energy prices), but they don't want to make the same mistakes of the past either," he said, referring to 2022 when central banks mistakenly judged the post-COVID, post-Ukraine invasion surge in inflation to be temporary.

The ratcheting up of the war also sent Europe's natural gas prices surging as much as 25% to their highest levels of the crisis so far. Wall Street futures though were pointing lower again, with the S&P 500, Dow Jones and Nasdaq down between 2% and 5.5% this month.

U.S. President Donald Trump said an angry Israel had "violently lashed out" when it attacked Iran's major gas field on Wednesday. Iran then responded by firing missiles at gas and oil facilities in Qatar, Saudi Arabia and Kuwait.

In the currency markets, the yen remained near the key 160 per dollar level as the BOJ left its interest rates unchanged. It left traders on watch for possible FX intervention after strong comments from Japanese Finance Minister Satsuki Katayama earlier in the day.

WORLD STOCKS DROP

The Nikkei and South Korean equities both dropped around 3% overnight, while MSCI's broadest index of world shares fell another 0.8% to its lowest level of the year so far.

"This latest escalation feels like a turning point for markets because the conflict is no longer just about military headlines or Strait of Hormuz closure," said Charu Chanana, chief investment strategist at Saxo in Singapore.

"It is now hitting the plumbing of the global energy system. What is unsettling markets now is the growing stagflation risk... It means this is no longer just a geopolitical story but a macro one."

The dollar edged up across the board, also buoyed by the Federal Reserve predicting just one more cut this year as the central bank left rates unchanged on Wednesday. Traders though are no longer fully pricing in any easing in 2026.

The dollar index, which measures the U.S. currency against six other units, is up 2.5% since the war broke out at the end of February as investors look to the greenback as the haven of choice. The index was last at 100.15, up fractionally after a 0.7% rise on Wednesday.

The two-year U.S. Treasury yield, which typically reflects near-term rate expectations, was up roughly 6 basis points to 3.8%, its highest since August 2025.

ECB FLAGS ENERGY PRICE RISK

In a week filled with policy meetings across the globe, investors have been parsing comments to gauge the impact of the war.

The ECB said the Iran war would "have a material impact on near-term inflation through higher energy prices", adding: "Its medium-term implications will depend both on the intensity and duration of the conflict and on how energy prices affect consumer prices and the economy."

The Bank of Japan had left its short-term policy rate at 0.75% as widely expected overnight, but it joined the U.S. Federal Reserve and Bank of Canada in striking a cautious tone about the war and pricing pressures.

The yen was last at 159.71 per dollar, having dropped over 2% against the dollar this month.

Fred Neumann, chief Asia economist at HSBC, said the path ahead for the BOJ is narrowing, noting rising price pressures from soaring energy costs and a weaker currency are pointing to prompt and decisive tightening.

BOJ chief Kazuo Ueda offered few clues on how soon it could raise rates again in his post-meeting press conference. But he said its next quarterly review of growth and inflation forecasts, due in April, will be key.

(Reporting by Marc Jones; Editing by Sharon Singleton, Aidan Lewis)