UPDATE 1-Political woes push Italy's debt costs to nine-month high
* One-year yields at auction hit highest since Dec 2012
Offers up to 7.5 bln euros in longer-dated bonds on Thursday
* Government's survival at stake over Berlusconi's future
By Valentina Za
MILAN, Sept 11 (Reuters) - The threat of a political crisis pushed Italy's funding costs higher at an auction on Wednesday, with the world's fourth-largest debtor paying more to borrow over one year than it has since December 2012.
Fears the governing coalition will not survive if former prime minister Silvio Berlusconi is expelled from the Senate following a tax fraud conviction have already hit Italian bonds trading in the secondary market.
On Wednesday, the Treasury paid 1.34 percent to sell 8.5 billion euros in one-year bills, up from 1.05 percent at a similar sale a month ago. Demand totalled 1.4 times that amount, slightly down from 1.5 times at the previous auction in August.
"Italian yields remain at acceptable levels," said ING rate strategist Alessandro Giansanti. "But it is clear that the market doesn't like the domestic political tensions."
Analysts say the higher yields encourage domestic demand, helping the Treasury meet its pressing funding needs. About two-thirds of Italy's 2 trillion euro debt is held domestically.
But an auction of longer-term bonds on Thursday for up to 7.5 billion euros will test appetite for Italian paper among international investors.
The bond sale will take place shortly before lawmakers resume a debate on centre-right leader Berlusconi's political future.
The issue threatens the survival of Italy's fragile left-right coalition. Supporters of the former premier have threatened to pull out of Prime Minister's Enrico Letta's government if he loses his seat.
A meeting of the Senate committee charged with the decision ended without holding a vote on Tuesday, easing tensions in the immediate. Hearings resume on Thursday at 1300 GMT.
Analysts see early elections as unlikely but say a government reshuffle is possible. It would come at a time when Italy is due to draft next year's budget, seeking to contain a public debt already projected to exceed 130 percent of output.
In a move set to further swell the debt, Italy plans to up the ceiling on 2013 net debt issuance by more than a fifth to 98 billion euros, a Senate panel said on Tuesday.
Domestic political woes and supply pressure have reduced the appeal of Italian bonds compared to Spanish ones. On Tuesday the yields on Italian 10-year bonds rose above those of Spain for the first time since March 2012.
On Wednesday, Italy also sold 3.0 billion euros of one-off bills maturing in late December at an average 0.51 percent yield. The smaller sale was covered 2.3 times as investors sought to park year-end liquidity.