By Sudeshna Ghoshal, Johann M Cherian and Ragini Mathur
Sept 2 (Reuters) - European shares edged lower on Wednesday, pressured by elevated bond yields as escalating tensions in the Middle East stoked worries about energy-induced inflation.
The pan-European STOXX 600 closed down 0.2% at 645.94 points, after hitting one-month lows earlier in the session. Retailers led a majority of sectors lower with a 2.3% drop.
Brent crude prices traded above $95 a barrel, adding to inflation worries as the U.S. and
Iran traded more strikes overnight in the most serious escalation of the conflict between the two countries in weeks.
Europe is seen as especially vulnerable to the months-long conflict given its reliance on energy imports, but strong earnings during the latest reporting season were a relief to investors and cushioned some of the STOXX's losses on signs that companies were coping better than expected.
"The backdrop is still relatively positive and that growth has been surprising to the upside, at least from a European perspective. So that gives us some support," said Gordon Kerr, European macro strategist at KBRA.
"But concern about elevated prices is what's driving uncertainty in the short term."
Elevated government debt in regional economies, such as France, Italy and Britain, has been in focus as higher interest rates could add to fiscal burdens.
The yield on German 10-year bonds hit its highest level since April 2011. Investors see a nearly 100% chance the European Central Bank will increase interest rates by 25 basis points next week, while nearly a half-percentage-point rate hike is expected by the year-end, LSEG-compiled data showed. [EUR/GVD]
Germany's DAX shed 0.5%, while France's CAC 40 dropped 0.3% after hitting a near two-month low earlier in the session. French stocks took a beating last week on fiscal concerns ahead of next year's election.
Higher rates are seen as broadly positive for lenders and, on Wednesday, banking stocks helped limit losses on the STOXX index, jumping 0.6%.
ING led the gains in the sector, rising 2.4%, after Morgan Stanley raised the stock to "overweight" from "equal-weight."
The brokerage said the mid-term "earnings picture" for European banks stays positive amid loan growth and resilient investments in manufacturing.
Lottomatica tumbled 7.7% after the Italian betting firm said it will take over Spain's Cirsa to create a combined entity. Cirsa jumped 18.5%.
Shares in Syensqo rose 3.3%. Traders pointed to a media report that several private-equity firms were considering a bid for the Belgian chemicals company's Performance & Care unit.
Volkswagen shares dropped 3.2% after index provider STOXX said the Finnish telecom equipment maker Nokia Oyj would rejoin the Euro STOXX 50, replacing the automaker.
(Reporting by Sudeshna Ghoshal and Johann M Cherian and Ragini Mathur in Bengaluru; Editing by Saumyadeb Chakrabarty, Mrigank Dhaniwala and Chris Reese)
