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UPDATE 2-Italy's bond yields rise after Salvini calls time on government

Virginia Furness

* Yields up 26 bps after League leader calls end to govt

* 10-year yield hits one-month high of 1.814%

* Italy/Germany spread closer to key 240 bps level (Updates pricing, adds chart)

LONDON, Aug 9 (Reuters) - A selloff in Italian government bonds accelerated on Friday, with the government on the brink of collapse after League leader Matteo Salvini said his coalition with the 5-Star Movement was untenable and called for early elections.

After months of tension, Salvini said on Thursday there was no way to patch up the parties' differences. He told Prime Minister Giuseppe Conte the alliance had collapsed and "we should quickly give the choice back to the voters".

Nervous investors dumped Italian debt, pushing yields on its 10-year bonds up 27 basis points to 1.814% - a five-week high and the biggest daily rise since May 2018, before yields retrached slightly lower to stand at 1.7920%.

Shorter-dated Italian yields also rose sharply, with the two-year up 27 bps at 0.283%, and the five-year up 15 bps at 1.105%.

The Italy/Germany 10-year bond yield gap widened to a five-week high of 237 bps, coming closer to the 240 bps mark that some analysts view as a technical ceiling.

The magnitude of the moves surprised some, however, with Christoph Rieger, rates strategist at Commerzbank, saying followers of political developments in Italy should not have been completely caught off guard.

"Yes, the uncertainty is calling for a higher risk premium and wider spreads, but once the uncertainty has lifted, a new centre-right government is unlikely to advocate fiscal and economic policies that are worse than the current government," he said.

Italy, which has Europe's second-largest sovereign debt burden after Greece, has angered the European Union with an expansionary 2019 budget and Salvini wants to make major tax cuts next year, setting up the prospect of another clash with Brussels.

Though it averted an excessive deficit procedure this year, Italy is due to present its 2020 budget to the EU by mid-October. The political uncertainty may delay this process and commentators suggest that President Sergio Mattarella - the only person who can dissolve parliament - will want to secure the budget process before going to the polls.

"It is uncertain whether he can find enough support in parliament for a technocratic government that would have to make difficult fiscal choices, however," wrote ING rates strategists in a note.

ING expects further widening in Italian spreads and expects the 10-year BTP-Bund spread to test 250bp in the short term, and then 300bp if elections take place this year without a 2020 budget in place..

"There's huge uncertainty over the timing of the break-up of the government," said Daniel Lenz, rates strategist at DZ Bank. "If we have snap elections in October, that is really bad timing because the government has to deliver the 2020 budget plan to Brussels."

Ratings agency Fitch is due to publish a review of Italy's credit rating after markets close, which will be a key focus for investors.

Italy is rated BBB by S&P, Baa3 by Moody's and BBB by Fitch.

German government bond yields reversed Thursday's rises after a senior government official said Berlin was considering a fiscal U-turn to issue new debt to finance a climate protection programme.

The 10-year Bund yield was at -0.582%, from a high on Thursday of -0.523%.

(Reporting by Virginia Furness; editing Josephine Mason and John Stonestreet)