* New MiFID II financial rules take effect
* Most euro zone bond yields lower on day
* Ireland launches 10-year syndicated bond
* ECB's Nowotny says bond buying could end in 2018
* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (rewrites throughout)
LONDON, Jan 3 (Reuters) - Euro area borrowing costs edged lower on Wednesday, stabilizing as a sweeping reform of EU financial market rules took effect a day after hawkish comments by ECB rate-setters drove a bond market sell-off.
The yield on Germany's 10-year government bond, the benchmark for the region, was down 3 basis points at 0.437 percent, recovering from two-month highs it held on to for much of the morning session.
The gap with its Italian counterpart tightened to 160 basis points, as Italy's own 10-year borrowing costs dropped 6 bps to 2.03 percent.
Most core euro zone bond yields were down 1-4 bps on the day.
Analysts said that a significant bond redemption in Germany helped explain the fall in yields.
"We've come a long way down in prices and we had a redemption in Germany, so there many have been some cash being put back to work," said Orlando Green, European fixed income strategist at Credit Agricole.
Ireland is expected to kick off a very busy supply month for euro zone bonds with the launch of a 10-year syndicated issue later on Wednesday for between 3-4 billion euros.
European stock and bond volumes were generally light after major new securities regulations came into force, although traders said there was little in the way of serious disruption.
Under the new MiFID II - or Markets in Financial Instruments Directive II - rules, trades in financial assets and instruments must all be logged in a repository, forcing banks, asset managers and traders to report detailed information on trillions of euros of transactions.
Fixed income volumes were lower at 1000 GMT compared to their average at that time over the previous 30 days, according to data provider Trax, a subsidiary of MarketAxess that tracks around 65 percent of all secondary market deals.
The new regulatory regime was delayed by a year due to its complexity, and regulators have had to issue eleventh-hour guidance to banks and financial firms to avoid trading freezes as well as calming the nerves of those not yet fully compliant.
Strategists said they expected investors to refrain from making large trades until they had a clearer sense of the impact of the reform.
Bond investors were also keeping a close eye on the U.S Federal Reserve's December meeting minutes and U.S ISM PMI manufacturing data, both due later in the day.
(Reporting by Fanny Potkin; Additional reporting by Dhara Ranasinghe; editing by John Stonestreet)