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Italy-Spain yield spread shrinks as investors discount politics

* Italy-Spain bond yield spread at 30 bps; half Sept. level

* Yields across the bloc edge lower after Powell appointment

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

LONDON, Nov 3 (Reuters) - The premium investors demand to hold Italian debt over Spanish hit its narrowest level in over a year and was half what it was just six weeks ago on Friday as bond markets priced out political risk in the euro zone.

Analysts believe a change in electoral law in Italy reduces chances of a populist outcome in next year's Italian election and Madrid's decisive approach to shutting down Catalonia's bid for independence has won the approval of bond market investors.

In general, investors have piled into Southern European debt recently and Italian, Spanish, Portuguese and even Greek borrowing costs have all fallen sharply over the past month.

Analysts say the market is cashing what it sees as waning of political concerns in the bloc against a backdrop of still easy monetary policy.

"Whether it is justified or not, market is not worrying about the Italian political scene at the moment and on the other hand there are hopes that the fundamental situation is improving with higher growth and less pronounced problems in the banking sector," said DZ Bank strategist Daniel Lenz.

"The overall situation of improving growth numbers in the euro zone in combination with the ECB sticking to their expansionary path is very positive for peripheral spreads."

Earlier this year, Italian polls suggested that anti-establishment party 5-Star Movement could take advantage of growing scepticism towards the single currency and make gains ahead of next year's election.

This, in combination with concerns over a possible withdrawal of stimulus from the European Central Bank, pushed the Italian 10-year bond yield spread over Germany to 180 basis points and the spread over Spain to 62 bps around September and October.

On Friday, the Italy spread over Germany was at 142 bps and over Spain was at 30 bps -- both at their narrowest levels in well over a year.

Euro zone government bond yields plummeted last week after the ECB said it would extend its asset purchase programme until at least September 2018, albeit at a reduced pace.

Italian debt -- seen as one of the biggest beneficiaries of ECB largesse -- has been a particularly strong performer since, a trend that accelerated after a surprise ratings upgrade from S&P and the approval of a new electoral system.

Most other euro zone bond yields also edged lower on Friday after U.S. President Donald Trump appointed Federal Reserve Governor Jerome Powell, seen as marginally more dovish than other candidates, the new head of the U.S. central bank.

The yield on Germany's 10-year government bond, the benchmark for the region, was a basis point lower at 0.36 percent.

Non-farm payroll data from the U.S. due later on Friday could inform the pace of future rate hikes, though most analysts now expect the Federal Reserve to hike rates for the third time this year in December.

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 Emelia Sithole-Matarise)