* Catalonia holds regional election
* Madrid hopes vote will end region's independence bid
* Spanish bond yields nudge lower
* German bonds yields hold near highs
* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr
LONDON, Dec 20 (Reuters) - The premium investors demand for holding Spanish bonds over top-rated German peers held close to its narrowest levels in three months on Thursday, as Catalonia holds an election that Spain's government hopes will end the wealthy region's independence bid.
After two days of heavy selling in U.S. and European bond markets, euro zone bond yields held near multi-week highs as the U.S House of Representatives approved a sweeping overhaul of the U.S tax code.
Spain's government hopes that the Catalonia election will strip pro-independence parties of their control of the Catalan parliament and end their campaign to force a split with Spain.
But while final polls showed separatist and unionist parties running neck-and-neck, an effective pro-independence majority remains a likely outcome.
"It (the election) cannot be ignored going into year-end," said Orlando Green, European fixed income strategist at Credit Agricole. "But the secession movement has been significantly diminished and would need a decisive move to revive it."
A new separatist majority would further dampen investors' confidence in Catalonia, which by itself has an economy larger than that of Portugal and is the main driver of Spain's economic growth. However, pro-independence leaders have backed away from demands for unilateral secession.
Spanish 10-year borrowing costs were at 1.48 percent in early trade, more than 30 basis points lower than the 1.81 percent hit that followed the October referendum on independence.
The gap with 10-year German bond yields was at around 107 basis points and close to its tightest in almost three months.
Analysts said markets were confident about the outcome of the Catalan election and had shrugged off the risk of secession.
"Our view is that buying ahead of the election is acceptable risk reward, given that a surprise win for separatists may simply lead to negotiations for greater autonomy," Mizuho said.
"If the polls are right, that separatists fail to gain a majority, then the Spanish economy can resume its recovery and the market should revert to pricing Spain gaining semi-core status in the forwards," its analysts wrote in a note.
Voting stations in the affluent region of northeastern Spain opened at 0800 GMT and close at 1900 GMT. The election is expected to draw a record turnout.
Most other euro zone bonds were up 0-1 bps on the day, after the Republican-controlled U.S. House of Representatives gave final approval to the biggest overhaul of the U.S. tax code in 30 years, sending a sweeping $1.5 trillion bill to President Donald Trump for his signature.
(Reporting by Fanny Potkin and Dhara Ranasinghe; Editing by Alison Williams)