Euro zone yields flat, ECB 'rate hike genie out of the bottle'

* ECB cites inflation risks, may discuss hikes

* Major banks now expect ECB April hike

* Italian bonds under pressure due to energy dependence, yields rise

By Amanda Cooper

LONDON, March 20 (Reuters) - Euro zone government bond yields were steady on Friday after a rout the day before, when inflation warnings from major central banks, including the European Central Bank, drove investors to swiftly price in interest rate rises this year.

The ECB left interest rates unchanged, as expected, on Thursday, and policymakers expect to discuss hikes in the coming months as the surge in oil and natural gas prices due to the Iran war pushes up inflation in the euro zone.

A number of major banks on Friday said they now expect the ECB to raise rates next month, while policymaker Joachim Nagel told Bloomberg News in an interview published on Friday the central bank will need to consider raising borrowing costs in April if inflationary pressures build due to the Iran war.

Two-year bonds around the world took the biggest hit, particularly in Britain, where short-dated gilts rose by more than 30 basis points at one point in the day. Two-year Schatz yields ended the day up 12 bps at 2.566%, having hit nine-month highs. By Friday morning, they were steady at 2.56%.

G10 CENTRAL BANKERS FOCUS ON INFLATION

Thursday's selloff in government bonds had already been underway before the ECB meeting, as oil jumped above $100 a barrel and gas prices soared 20%. Most of the big G10 central banks, including the Federal Reserve and Bank of England, had held policy meetings over the course of Wednesday and Thursday and all sounded a similar note.

Yields on 10-year Bunds, which serve as a benchmark for the wider euro zone, were roughly unchanged at 2.96%.

Prior to the conflict, markets showed traders were attaching a roughly 40% chance to another ECB rate cut this year. That has now flipped to one hike fully priced in by June and a 60% chance of one at the May meeting.

"If central bank commentary this week is anything to go by, inflationary concerns were given more significance over growth challenges from this shock given the memory of the recent high-inflation episode," Rohan Khanna, a strategist at Barclays, which is now calling for an April hike, said.

"While March flash PMIs next week could bring growth back into the spotlight, we continue to think inflation risks and hence oil and gas price gyrations will remain front and centre for the EUR rates market - especially now that the ECB rate hike genie may be out of the bottle," he said, referring to next week's monthly business activity surveys.

ITALY UNDER PRESSURE

Italian 10-year bond yields were also flat at 3.784%, having risen on Thursday by as much as 12 bps at one point. Given Italy's greater dependence than many of its neighbours on imported energy, its bonds have come under more pressure since the start of the war in late February.

BTP yields have risen 50 bps since then, compared with a 40-bp rise in French and Spanish yields and a 30-bp rise in German Bund yields, which has brought the gap between those two - one market indicator of risk aversion - to nearly 80 bps, its widest since last October. (Reporting by Amanda Cooper; Editing by xxxx)