UPDATE 4-Investors cheer centre-left lead in Italy polls
* Italy stocks up, bonds gain on posible centre-left victory
* Italy sells 4.07 bln euros of CTZs, BTPei at auction
(Recasts with release of polls after voting ends)
MILAN, Feb 25 (Reuters) - Italian shares and bonds rallied sharply, lifting European shares and the euro, after the first polls from a crucial election showed the pro-reform centre-left was well ahead of former premier Silvio Berlusconi's conservative bloc. The centre-left was ahead by 5.5 percentage point in the lower house and by 6 percent in the Senate, according to a telephone poll for Italy's Sky television published as voting ended at 1400 GMT. That helped to lift European shares and forced German Bund futures to extend losses.
The euro was up nearly one percent against the dollar on the day with forex traders closely following political developments in Italy, the euro zone's third-largest economy.
Yet, results looked tied in the key swing region of Lombardy which the centre-left will need to be sure of control of both houses of parliament.
Beppe Grillo's anti-establishment party appeared to be a distant third.
Italy's main FTSE MIB stock market index extended gains and was up 3.9 percent at 1430 GMT, while the bond yield spread between 10-year Italian and German bonds dipped below 255 basis points, its lowest since mid-January.
"From the polls, it looks like (PD leader Pierluigi) Bersani has got it, even in the Senate (upper house), though there's a bit of doubt surrounding the outcome in the swing Lombardy region," said a fund manager at a large Milan investment house.
"The market didn't want Berlusconi back in the driving seat and the polls are showing the centre-right is coming out a loser. It will be Bersani who decides whether he needs (centrist Prime Minister Mario) Monti or not."
Italy's complex electoral law could deliver a hung parliament if the winning coalition does not manage to secure enough seats in the Senate (upper house).
Italian bank shares rallied strongly. UniCredit, which had to be suspended limit-up in heavy trading, was indicated up 8 percent. Berlusconi's Mediaset, which had suffered losses in the run-up the elections, was also up 9 percent.
Opinion polls before the vote and a low turnout on the first day of voting on Sunday prompted some traders to place bets already earlier on the day on a victory for the centre-left Democratic Party (PD) of Bersani in coalition with outgoing Prime Minister Mario Monti.
Heavy snow in several Italian cities and bad weather elsewhere kept some voters away from polling stations on Sunday, when turnout was around 55 percent, down from 62.5 percent at a previous election. This had possibly hurt Berlusconi, whose voters tend to be older, traders said.
"We have to wait for the confirmation, of course, but the market is relieved that Berlusconi won't play an active role in the government," said Michael Leister, rate strategist at Commerzbank.
"This tail risk is not materialising and it allows the BTPs to recover quite well. Also, Bersani might be able to form a government with Monti. They get these extra seats so they might come close to a stable majority."
Earlier on Monday, the Italian Treasury paid slightly higher borrowing costs to sell 4.07 billion euros - near the top of its targeted amount - of 2-year zero-coupon bonds and inflation-linked BTPs.
But at 1.68 percent, the yield paid was well below the 1.80 percent of the secondary market, traders said.
(Additional reporting by Francesca Landini, Silvia Aloisi, Giulio Piovaccari and Jennifer Clark in Milan, and Marius Zaharia in London; Editing by Keith Weir)