* Italy-German yield spread narrows as political worries ease
* But PIMCO warns of wide range of risks to come in Italy
* BoE's Carney reinforces benign monetary policy backdrop
* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Adds quote, updates prices)
LONDON, June 20 (Reuters) - The gap between Italian and German 10-year borrowing costs hit its narrowest level in five months on Tuesday as euro zone bond investors price in what they see as a dramatic reduction in the risk of the bloc breaking up.
Earlier this year, government bond yields in southern Europe rose due to uncertainty over how French elections in May would play out, the possibility of a snap vote in Italy and speculation of the European Central Bank beginning to wind down its extraordinary monetary stimulus.
Since then however, the ECB has indicated it is no hurry to end its programme, centrist Emmanuel Macron has become French president with a powerful parliamentary majority, and fears have faded of Italy facing a potentially disruptive election.
"The perception in the market is that the main political risks that were the dominating factors (in euro zone bond markets) are now behind us," said DZ Bank strategist Christian Lenk. "Investors are now happy to take some carry into the summer months."
The Italian-German bond yield spread, closely watched as a key indicator of political risk in the bloc, tightened to 165 basis points, its narrowest level since early January.
Most euro zone government bond yields dropped, but Spanish and Italian 10-year bonds were in particular demand, with yields 2-4 bps lower on the day.
Italian yields are close to their lowest level in five months at 1.94 percent.
However, this prompted a note of caution from the world's largest bond investor.
"You need to be generous to fund Italy at 2 percent given a wide range of risks that are coming," Andrew Balls, chief investment officer for global fixed income at PIMCO, told a Euromoney conference in London.
Italy will face elections in 2018, with anti-establishment party 5-Star Movement riding high in opinion polls.
There is also the possibility of a state bailout to support some of its ailing banks at a time when the debt-to-GDP ratio is over 130 percent.
Low-rated South European government bonds tend to rally when risk appetite is high and when the threat of euro zone break up is at an ebb.
The promise of continued monetary stimulus is also positive for lower-rated bonds in the bloc, and indications are that central bankers in major developed countries are all hesitating to tighten monetary policy.
On Tuesday, Bank of England Governor Mark Carney said now was not the time to raise rates.
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(Additional reporting by Dhara Ranasinghe,; Editing by Raissa Kasolowsky and Hugh Lawson)