UPDATE 5-Italian government tensions make for volatile day in bond markets

* Key budget meeting sparks worries over Italy budget

* Economy minister Tria says satisfied with outcome

* Italian 2-yr yields erase losses after Tria comments

* Italian Treasury buys back 950m euros of debt (Adds Tria comment, detail on Italy Treasury bond buyback, replaces graphic)

LONDON, Aug 3 (Reuters) - Italy's bonds tanked early on Friday as investors fretted over tensions within the government, before making up a large chunk of the losses during a volatile session in Italian bond markets.

Prime Minister Giuseppe Conte summoned top ministers to discuss next year's budget as investors concerned about Rome's spending plans sold Italian bonds and the national statistics bureau said the economy would keep slowing.

Following the meeting, Economy Minister Giovanni Tria -- who has been under pressure to ramp up spending and challenge European Union budget rules -- said he was satisfied with the framework for the 2019 budget agreed earlier in the day.

The possibility that he might be forced to resign had investors worried that Italy could go on a spending binge, or even that new elections could be triggered, so the comments served to soothe some nerves.

In addition, the Italian Treasury said it bought back 950 million euros of bills and government bonds as part of its regular operations, which have also supported the market.

So though Italy's two-year and five-year government bond yields had jumped 25 basis points in early trade to eight-week highs of 1.36 percent and 2.39 percent respectively, they fell back again. .

By the close, they were at 1.04 percent and 2.12 percent, just 7-8 bps higher on the day.

"An Italy two-year yielding more than 1 percent doesn't really make sense, that is a great buy opportunity. So someone woke up in the U.S., just saw it and bought it," a Milan-based government bond trader told Reuters.

"Not big orders, but enough to move this thin market."

Italy's 10-year bond breached 3.1 percent for the first time since early June, but ended the day at 2.93 percent.

The spread over Germany was about 8 bps wider on the day at 253 bps .

Some analysts warned that these moves were exacerbated by the low volumes, given many investors are on holiday.

The day's trading nevertheless confirmed that Italian politics is still a major driver of the bond market activity, and that investors are still watching developments closely.

"There isn't a huge amount of common ground between the two (coalition) parties and the potential for them to upset their European Union colleagues is very high," said Eoin Walsh, founding partner and portfolio manager at Twenty Four Asset Management, a bond fund with £13.5 billion of assets under management.

The fund added Italian BTPs in June after the initial spike wider in spreads and currently holds two-year and five-year debt. Walsh said he is waiting to see how the budgetary discussions proceed before acting on this position.

Also putting pressure on Italian yields are concerns over how rising Italian borrowing costs could affect the country's banks, which hold large amounts of government debt.

Data on Friday showed U.S. job growth slowed more than expected in July, probably due to companies' struggles to find qualified workers. The unemployment rate declined, pointing to tightening labour market conditions.

Yields held steady at recent lows, with 10-year U.S. Treasury yields 4 basis points lower than the day's open at 2.95 percent.

Most high-grade euro zone bond yields were also lower on the day, with benchmark German 10-year government bond yields down 4 bps at 0.41 percent.

(Reporting by Abhinav Ramnarayan; Additional reporting by Virginia Furness and Giulio Piovaccari in MILAN; Editing by Catherine Evans)