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UPDATE 1-Italian bonds in favour as investors look for green shoots of growth

* Italy-Germany bond yield spread narrows to 159 bps

* Expectations for Italy to grow 0.4 pct over previous quarter

* Euro zone yields rise as U.S. Fed minutes loom

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr

LONDON, Aug 16 (Reuters) - Italy's bond yield spread over Germany narrowed on Wednesday on expectations it would post strong growth numbers later on Wednesday and make its high debt levels easier to manage.

The gap between Italian and German 10-year borrowing costs, an indicator of risk sentiment in the euro zone bond market, narrowed 3 basis points to 159 bps on Wednesday ahead of the release of Italian economic output data, due 0800 GMT.

Expectations are for Italy's economy to have expanded 0.4 percent over the previous quarter and 1.4 percent over the same period the year before, according to a Reuters poll.

"If nominal GDP growth meets expectations, it will really help bring down the debt-to-GDP ratio, which is one of the key drivers of the (Italy-Germany) spread," said ING strategist Martin Van Vliet.

"We still expect the spread to widen out to over 200 bps ahead of next year's elections, but the growth momentum will certainly help keep that down."

At 159 basis points, the Italy-Germany bond yield spread is a whopping 50 basis points below some of the widest levels seen earlier this year, when French elections and the prospect of snap Italian elections weighed on the market.

The difference between Italian and German borrowing costs is driven by a number of factors, including the credit rating of the two countries, political risk and concerns over the Italian banking sector.

But underpinning these is Italy's high debt levels and its hitherto flatlining economy; the country went through a two-year recession following the debt crises of 2010-2012.

At 132.6 percent, Italy's debt-to-GDP ratio is still the highest in the euro zone after Greece and amongst the highest in the world.

"But if you are seeing some growth returning, that would be encouraging for Italy and the debt-to-GDP ratio can be brought under control," said Van Vliet.

Later on Tuesday, the U.S. Federal Reserve is due to release the minutes of its July policy meeting, and the market will be looking for any signs of when it will begin the process of unwinding a balance sheet that has swelled through years of post-crisis money printing.

High-grade euro zone bond yields were generally 1-2 basis points higher in anticipation of a more hawkish stance from the U.S. central bank.

The yield on Germany's 10-year government bond, the benchmark for the region, was 2 bps higher at 0.45 percent.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.bi z / c m s / ? p a g e I d = l i v e m a r k e t s

(Reporting by Abhinav Ramnarayan)