Adds closing prices, bond auction

By Steven Scheer and Libby George

JERUSALEM/LONDON, March 2 (Reuters) - Tel Aviv shares rose sharply to all-time highs on Monday and the shekel gained against the dollar on the first trading day after U.S.-Israeli strikes on Iran began on Saturday.

FX market gauges of potential future shekel volatility ILS1MO=FNILSSWO=FN hit their highest, however, since the last bout of major Israel-Iran conflict in June, with some analysts questioning if the spot market strength would last.

The blue-chip Tel Aviv 35 index .TA35 closed 4.6% higher while the broader TA-125 .TA125 rose 4.8%.

Energy, financial and defence company shares led the gains and while the country's government bonds US46513JXM88=TE, US46514BRM18=TE were fractionally lower, the shekel ILS= jumped 1.5% versus the dollar, near to a 30-year high reached last month.

"Investors are currently only plotting the most optimistic scenario: a relatively short campaign, with major successes and perhaps even the overthrow of the regime in Iran," said Gali Ingber, head of finance studies at the College of Management in Rishon LeZion, near Tel Aviv.

Ingber said that in a best-case scenario, Israel's risk premium could drop significantly, allowing the economy to grow, interest rates to decline further and the budget deficit to gradually shrink.

Last week, fears of a conflict with Iran led the Bank of Israel to hold the line on interest rates after two consecutive cuts and despite easing inflation pressures.

Sergey Dergachev, portfolio manager at Union Investment Privatfonds, said he did not expect the conflict, in which Iran has been firing missiles at Israel as well, to "materially affect the creditworthiness of Israeli banks and their spreads in a big way".

The Finance Ministry held its weekly bond auction and sold 3.3 billion shekels ($1.07 billion) of debt in the local government bond market, with demand reaching 20 billion shekels, it said. In addition to local banks, Barclays, Goldman Sachs, Bank of America, JP Morgan, BNP Paribas, Deutsche Bank and Citi participated in the auction.

The shekel's gains extended its near 20% appreciation versus the U.S. dollar over the past year and also came despite the greenback rising against most other world currencies on Monday.

"The shekel is in a relatively stronger position than oil importers, but we do not believe current dollar-shekel downside will be sustained," JPMorgan said.

The Wall Street bank added that direct risk for Israel was mitigated by Iran’s limited military capabilities, but risks remained.

"We believe the current shekel rally underestimates the potential for more protracted engagement in Iran and Lebanon with knock-on effects on the fiscal position, the labour market and other macro variables," it added.

"We thus stay on the sidelines, not chasing the levels in either direction."

($1 = 3.0863 shekels)

(Additional reporting by Marc Jones in London; Editing by Alison Williams)

((steven.scheer@thomsonreuters.com; +972 2 632 2210; Reuters Messaging: X: @StevenMScheer))