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UPDATE 1-Investors pile into Italian debt in final auction of 2017

* Over 9 bln euros of demand for 5 and 10yr Italian debt

* Italian parliament expected to be dissolved before end of week

* Most euro zone yields up 2-3 bps on the day

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (writes through)

LONDON, Dec 28 (Reuters) - Investors hoovered up Italy's government bonds on Thursday both at an auction and in the secondary market, as demand for the country's debt picked up again at higher yields after a recent sell-off prompted by concerns over an upcoming election. The euro zone's third largest economy sold 4.9 billion euros of five and 10-year bonds, or BTPs, generating over 9 billion euros of demand in the process.

Meanwhile, Italy's 10-year government bond yield edged lower to 1.90 percent on the day - yields normally rise during an auction as investors make space for supply - suggesting that investors were buying whatever they could.

"I think the auction went quite well, especially for the current holiday period," said DZ Bank analyst Sebastian Fellechner.

"I think yesterday we saw some spread widening that has made Italian bonds more attractive, that is why maybe investors are taking advantage," he said.

The drop in Italian borrowing costs on the day was notable given most other euro zone government bond yields were up 2-3 bps in midday trading.

The gap between Italian and German 10-year borrowing costs narrowed 2.5 basis points to just below 151 bps at one stage.

Italian government bond yields have risen in the last couple of weeks after reports emerged that a general election is set to take place in March.

Some investors sold Italian government bonds - which have been a stellar performer overall this year - on concerns that anti-establishment party 5-Star Movement is performing strongly in the polls. President Sergio Mattarella is widely expected to dissolve parliament before the end of the week, mostly likely later on Thursday, clearing the way for national elections planned for early March

Italy's ruling Democratic Party (PD), hit by internal divisions and a banking scandal, has been sliding in opinion polls, with a survey on Saturday putting it more than six points behind the eurosceptic 5-Star Movement.

"It appears unlikely that any of the three large political blocks that could be formed ahead (of) elections will be able to secure the outright majority needed ... to appoint a government and to win power," Barclays analyst Fabio Fois told clients earlier this month.

But having the current prime minister stay in office, as is expected, "would help contain concerns over the risk of a sudden political stability cliff straight after elections," Fois said.

(Reporting by Fanny Potkin and Abhinav Ramnarayan; Editing by Andrew Bolton)