Euro zone bonds battered as oil draws 'rate hike genie' out of the bottle

* Euro zone bond yields hit 15-year high as inflation fears grow

* ECB and BoE rate hikes likely in April, markets show

* Energy importers like Italy face greater bond yield pressure

* Spain proposes 5-billion euro package to cushion energy impact (Updates throughout)

By Amanda Cooper

LONDON, March 20 (Reuters) - Benchmark euro zone government bond yields hit their highest in 15 years on Friday, with oil prices heading towards their biggest three-week rise in nearly 40 years and the U.S. military preparing to deploy thousands of extra troops to the Middle East.

A rout in global bonds gathered pace on Friday, after central bankers around the world, including those at the European Central Bank, sounded the alarm over inflation risks this week, prompting investors to swiftly price in interest-rate hikes this year.

Yields on 10-year German Bunds, which serve as a benchmark for the wider euro zone, rose as much as 8 basis points to 3.035%, the most since 2011, while 2-year bonds, which are the most sensitive to shifts in expectations for rates and inflation, rose 10 basis points to 2.66%.

British 2-year gilt yields were up more than 20 bps, having risen by more than a percentage point since the start of the war, compared with a 65-bps rise in their German counterparts.

RATE HIKES MAY COME IN APRIL

Money markets showed traders are attaching a near-70% chance of a rate hike from both the ECB and the Bank of England as early as next month, with the ECB expected to raise at least once more after that and the BoE twice.

"The sad fact is there are significant upside risks to inflation and therefore the selloff makes sense. The repricing of the path of interest rates, at least in Europe, looks reasonable in light of the shock to energy prices," Chris Scicluna, head of research at Daiwa Securities, said.

"Unfortunately expectations for two, three, four, rate hikes could yet prove conservative relative to what happens."

Oil prices traded above $100 a barrel, set for a weekly gain of 6.5%, bringing the gain over the last three weeks to almost 52%, the largest three-week percentage increase since at least 1989, according to LSEG data.

On Thursday, ECB President Christine Lagarde said the euro zone was well positioned to deal with what she called "a major shock that is unfolding".

Kirstine Kundby-Nielsen, a senior analyst for fixed income and FX research at Danske Bank, said the outlook for ECB policy was not so clear cut and April might prove too soon for a rate hike.

"From the ECB speakers out since the war began, it appears that the ECB is highly divided. Markets are struggling to find firm footing," she said.

ENERGY IMPORTERS HIT HARDER

Within the euro zone bond market, Italian yields have risen far more quickly than those elsewhere, given Italy's greater dependence on imported oil and gas.

Italian 10-year bond yields were up 16 bps at 3.94%, set for their biggest one-day rise in a year.

BTP yields have risen 70 bps since then, compared with a 50-bp rise in French and Spanish yields and a 35-bp rise in German Bund yields, which has brought the Italy/Germany yield difference - one market indicator of risk aversion - to 90 bps, its widest since last September.

Spain's government on Friday proposed measures worth 5 billion euros ($5.8 billion) to counter the economic impact of the war on local energy prices that, if approved, would be some of the first enacted to cushion the impact of the Middle East conflict for households. Spanish bond yields were up 11 bps on the day at 3.574%.

"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," Rohan Khanna, a strategist at Barclays, said. (Additional reporting by Dhara Ranasinghe; Editing by Shri Navaratnam, Chizu Nomiyama and Alex Richardson)