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UPDATE 2-Southern European bond yields tumble as growth worries ebb

Dhara Ranasinghe and Virginia Furness

* Core EZ bond yields edge up after Fed holds rates

* EZ PMI points to third month of contraction

* But southern EZ bond yields at new lows

* Greek manufacturing growth hits 19-year high

* Euro zone periphery govt bond yields (Recasts with move in peripheral bonds)

LONDON, May 2 (Reuters) - Spain's 10-year bond yield hit its lowest level since late 2016, while other southern euro zone debt yields tumbled on Thursday as data eased fears about the growth outlook.

In contrast, yields on higher-rated bonds such as Germany faced some upward pressure a day after the U.S. Federal Reserve signalled little appetite for hiking or cutting rates.

A rally in peripheral bonds prices, pushing yields lower, gathered pace after data showed growth in the Spanish manufacturing sector expanded in April at its fastest rate since January.

Greek manufacturing expanded at the fastest pace in 19 years in April, according to Markit's Purchasing Managers' Index. And in Italy, while the PMI data showed manufacturing activity contracted for a seventh consecutive month in April, the rate of decline slowed.

Spain's 10-year government bond yield fell to 0.967 percent , its lowest since late 2016, pushing the gap over top-rated German peers to its tightest in around seven months at around 95 basis points.

Italian 10-year bond yields fell three bps to its lowest in over two weeks at around 2.53 percent, while Portuguese yields hit fresh historic lows at 1.09 percent .

"Both the Spanish and Italian manufacturing PMIs were comfortably above expectations," said Peter Chatwell, head of rates strategy at Mizuho.

"That would cause Spanish and Italian bonds to outperform and there is demand generally for EGBs (European government bonds)."

Higher-rated euro zone bond yields inched up after a pause in trading for the May Day holiday, tracking a rise in U.S. Treasury yields after the Federal Reserve left rates unchanged and signalled little appetite to adjust them any time soon.

Fed chief Jerome Powell acknowledged a modest pick-up in growth in the first quarter, which marked a shift from previous statements, but analysts noted the reference was past tense, and took the comments to mean the Fed did not expect growth to necessarily continue.

"There's concern among the Fed that the positive impact of the tax cuts is beginning to wane, and growth may indeed prove softer going forward," said Matt Cairns, rates strategist at Rabobank. "The language is neither prompting an acceleration in terms of monetary policy, or a deceleration."

But data from both sides of the Atlantic, which suggested that signs of growth in the first quarter will not be sustained, limited the rise in yields.

Germany's benchmark 10-year government bond yield was 0.5 basis points higher at 0.02 percent, in line with moves of most other core 10-year bond yields in the bloc., ,

Data on Thursday showed euro zone factory activity contracted for the third month in a row in April.

German retail sales meanwhile fell by 0.2 percent on the month in March, due largely to sharp drops in sales of food, drink and tobacco.

(Reporting by Virginia Furness and Dhara Ranasinghe Editing by Frances Kerry)