UPDATE 2-Italian bonds get thumbs up in pre-election auction, markets digest Powell remarks

Powell remarks@

* Italy-Germany bond yield spread tightens

* Key election looms this weekend

* Italy sells 7.711 bln euros of bonds in auction

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates with Powell comments)

LONDON, Feb 27 (Reuters) - Italian government debt outperformed euro zone peers on Tuesday as investors snapped up the country's last bonds to be auctioned before an election this weekend, while comments from the new Fed chief Jerome Powell eased broader markets.

In his first prepared testimony as chairman on the Federal Reserve, Powell said the U.S. central bank would stick to a gradual approach to raising interest rates with inflation stuck below its 2 percent goal.

Euro zone bond yields initially rose after the comments but soon trimmed those rises in line with U.S. bond yields.

In Europe, Italy remained a key focus. The southern European country, which goes to the polls on Sunday, sold around 7.71 billion euros of debt.

That was towards the top end of a targeted range, helping support Italian bonds and suggesting sentiment towards Italian assets ahead of the election remains firm.

"Given the risks we have ahead of the election and with bond yields turning up, the auction results saw fair demand," said Daniel Lenz, a rates strategist at DZ Bank.

Italy's 10-year bond yield was 2 basis points lower at 2.09 percent, while most other long-dated euro zone bond yields were flat to 1 basis points higher on the day.

The gap between Italian and German bonds yields narrowed to 143 bps, its narrowest in five days and below recent highs of 152 bps.

That spread has widened in recent weeks as the election has approached, making Italian bonds more attractive to those investors who take a more sanguine view of political risk in the euro zone's third-largest economy.

Analysts said the market is looking beyond the election, expecting most of the tail risks to be averted.

Polls point to a hung parliament. But while they suggest the anti-establishment 5-Star Movement is by far the most popular single party, a centre-right coalition led by Forza Italia and the League party looks the most likely outcome.

"(Italian centre-right leader Silvio) Berlusconi has changed the game by taking away some of the people who were ready to go for 5-Star, which makes it harder for (5-Star leader) Beppe Grillo to have a majority," said Francois Savary, CIO at Swiss Wealth Manager Prime Partners.

Germany's 10-year bond yields rose 1.5 bps to 0.67 percent, shrugging off news that German inflation has slowed.

But Bundesbank President Jens Weidmann said on Tuesday that rapid and broad-based economic growth would ensure inflation continues to rise, so the European Central Bank should gradually reduce its stimulus.

(Reporting by Fanny Potkin and Abhinav Ramnarayan with additional reporting by Sujata Rao editing by Mark Heinrich)