April 12 (Reuters) - Euro zone government bond yields

dropped sharply on Friday as markets increased bets on future

European Central Bank rate cuts and fears of a broadening of the

Middle East conflict triggered bids for safe-haven assets.

The ECB said on Thursday it might cut rates soon but failed

to trigger a repricing of market bets on future rate cuts after

strong U.S. economic data led investors to reduce expectations

for future monetary easing there.

Gold surged to a fresh peak on Friday, supported by

safe-haven demand amid the tension in the Middle East.

Market participants said investors were closing some short

positions on euro area government bonds opened during two weeks

of strong U.S. data and hawkish remarks from Federal Reserve

officials, as fears of a confrontation between Iran and Israel

and the U.S. weighed on market sentiment.

"We do see geopolitical risks impacting markets a bit more

than usual, with investors watching closely developments on

Israel and Iran," Joost van Leenders, senior investment

strategist at Van Lanschot Kempen, said.

Israeli Defence Minister Yoav Gallant said on Thursday that

Israel would respond directly to any attack by Iran. The

Pentagon said it discussed with Gallant the United States'

"iron-clad" commitment to Israel's security against threats from

Iran and its proxies.

"Today's fall in yields is all about investors closing short

positions they opened after strong U.S. economic data," said

Massimiliano Maxia, senior fixed income specialist at Allianz

Global Investors.

Germany's two-year government bond yield, more

sensitive to the outlook of policy rates, dropped 7 basis points

(bps) to 2.90% and was set to end the week 3 bps higher. The

benchmark 10-year Bund yield fell 9 bps to 2.39%.

Money markets last priced in around 83 bps of monetary

easing by the ECB in 2024 from 75 late on

Thursday and from 87 bps on Wednesday before the U.S. data. They

also discounted an around 90% chance of a 25-basis-point first

move by June.

Markets also priced 45 bps of Fed rate cuts in 2024 from 40

bps the day before, raising to 80% the chances of a second rate

cut this year.

The ECB policy meeting was relatively uneventful for the

market as the ECB confirmed it would be data-dependent, with

economists looking for hints about the future policy path.

"We interpret some of the indirect messages on inflation and

financial conditions as being on balance more consistent with

gradual/quarterly cuts than continuous/back-to-back cuts,"

Deutsche Bank chief economist Mark Wall said.

"President Lagarde also argued the ECB is independent of the

Fed, but at the same time was clear that U.S. data is taken into

account," he added.

Some analysts said an ECB rate cut in June was probably a

done deal but the Fed monetary policy would significantly affect

the ECB path beyond.

"Bund yields risk being pulled higher by (U.S.) Treasuries,

and a weaker euro in forex terms could also become a factor

limiting the ECB over the months ahead," said Mark Dowding,

BlueBay CIO, RBC BlueBay Asset Management, after mentioning the

need of policy divergence between the Fed and the ECB.

The Italian 10-year bond yield was 11.5 bps

lower at 3.75%. The gap between Italian and German 10-year

borrowing costs - a gauge of risk premium investors ask to hold

bonds of the euro area's most indebted countries - tightened to

135 bps.