Euro zone government bond yields dipped on Thursday, and traders further reduced bets on an imminent ECB rate hike, as optimism grew that the war in the Middle East may be near an end, though, unlike world stocks, bonds remain well off pre-war levels.

Germany's 10-year bond yield, the euro zone benchmark, dropped 3 basis points to 3.02%, DE10YT=RR moving further from late March's high of 3.13%.

It is, however, still much closer to its highs than pre-war levels around 2.7%, as traders anticipate the energy price surge caused by the war, and its potential for spilling over into broader inflation, will still force the European Central Bank to raise interest rates.

Markets are currently pricing two 25 basis point ECB rate hikes this year, down from around three a few weeks ago. Before the war, however, traders saw some chance of an ECB rate cut in 2026. 0#EURIRPR

The optimism towards bonds, at least compared with late March, was helped by news a key Pakistani mediator was in Tehran and the administration of President Donald Trump was talking up hopes for a deal that would open the crucial Strait of Hormuz.

Israel's cabinet also met on Wednesday to discuss a possible ceasefire in neighbouring Lebanon, a senior Israeli official said.

Italian debt, which has been underperforming the German benchmark, outperformed. The southern European country's 10-year yield dropped 5 bps to 3.77%. IT10YT=RR

-Alun John/Reuters