×

UPDATE 2-Italian bonds in demand as green shoots of growth emerge

* Graphic: 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 (Adds Italian growth data, graphic)

LONDON, Aug 16 (Reuters) - Italy's bond yield spread over Germany narrowed on Wednesday as the southern European nation posted healthy growth numbers that should help keep its high debt levels in check.

Italy's economy maintained firm growth in the second quarter, in line with expectations, thanks to healthy domestic demand which offset a negative contribution from trade, data showed on Wednesday.

"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."

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.

At that level, the 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 at the end of 2016, 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 edged a touch higher on the day, perhaps in anticipation of a more hawkish stance from the U.S. central bank.

This was tempered by reports that European Central Bank President Mario Draghi will not deliver a new policy message at the U.S. Federal Reserve's Jackson Hole conference.

The yield on Germany's 10-year government bond, the benchmark for the region, was 1 bps higher on the day 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; Editing by Toby Chopra)