Array

LONDON, July 17 (Reuters) Oil fell back from record prices and gold dropped from its highest level in almost two months on Monday on reports Israel might soon end its Lebanon offensive, although the government quickly said it had no intention of halting operations against Hizbollah guerrillas yet.

Market volatility was whipped up as Israel's Channel 10 television quoted a senior military officer as saying Israel could wrap up its offensive within days but also that it could escalate its assault by destroying Lebanon's electricity grid.

Government spokesman Miri Eisin responded, saying: ''We have no intention of stopping as of yet.'' The dollar and government bonds stayed at month highs but shares failed to rally on the varying reports, on a day that Israeli air strikes killed a further 23 people in Lebanon.

United Nations Secretary-General Kofi Annan said at the G8 summit in St Petersburg that Security Council members would start working out details of a new multilateral force for south Lebanon but Israel dismissed the proposal as premature.

Oil should remain centre stage, especially as G8 leaders are expected to make a comment on high world oil prices to calm volatile markets.

Brent crude futures hit record highs of $78.18 per barrel, but fell back to $76.90.

''Eighty is on everybody's lips at the moment,'' said one London-based trader. ''We're still in an uptrend and it looks like we'll be in it for some considerable time.

''We have the Israel situation and if they drag Syria and Iran into it, well nobody is going to want to short this market.'' The same could be said for Gold, which hit a two-month high of $674 an ounce on heavy demand, but then dropped to $667.

DOLLAR STRONGER The dollar rose to monthly highs against the euro and yen as cautious investors shifted into dollar-denominated assets such as gold, oil and U.S. Treasury bonds.

''The dollar has been affected by a safe-haven bid and that could persist all week. It seems that a lot of money is flowing into U.S. Treasuries,'' said Daragh Maher, senior currency strategist at Calyon.

The dollar rose 0.5 percent to trade as high 117 yen.

The euro eased to a monthly low of $1.2535 before recovering to $1.2540. It had been as high as $1.2861 earlier this month before the flare-up in global tensions.

''I expected the market to be a little bit more strong, but probably this effect is running out -- geopolitics usually has only a short impact on the markets,'' said Peter Mueller, interest rate strategist at Commerzbank.

Euro zone government bonds also gained, briefly touching their highest levels in almost a month amid the worsening conflict in the Middle East, but then went into revers.

''There have been a few sellers into strength. At the moment the Middle East situation is sort of in the price unless things deteriorate further.'' At 1045 GMT, the Bund future was down 5 ticks on the day at 116.10, while benchmark 10-year euro zone government bonds were flat, with yields at 3.979 percent.

SHARES DOWN European shares slipped 1 percent as fears about escalating violence in the Middle East offset gains in electronics giant Philips after it announced booming sales and a share buyback.

The FTSEurofirst 300 index of top European shares was trading 0.7 percent down at 1,268.1 points.

The benchmark had opened higher but quickly dropped back as nagging fears over inflation, rising borrowing costs, record oil prices, patchy earnings and global security dogged markets.

The FTSEurofirst is now 10 percent below a near five-year high hit on May 11 and has lost its gains for the year in a steady two-month correction.

''The market staggered along for the first few minutes and then it started to stutter,'' said a trader. ''At the end of the day all you have is a very thin veneer of confidence and it doesn't take much to push through it.

REUTERS CS RN1737