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UPDATE 1-Euro zone bond yields up on more promising PMIs

Virginia Furness

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Recasts to focus on euro zone PMI, Italian elections)

LONDON, Aug 22 (Reuters) - Most euro zone government bond yields rose on Thursday after data showed service activity picked up last month and manufacturing contracted less than expected.

Italian government bond yields fell on expectations a new government will be formed soon, as markets digested news that Federal Reserve policy makers were divided over the path of interest rates.

The euro zone's service industry expanded but factory activity contracted for the seventh month in a row, although at a slower rate than the previous month, according to IHS Markit's flash purchasing managers' indexes.

The composite PMI, which combines services and manufacturing and is considered a good guide to economic health, rose in August to 51.8 from 51.5 in July, above the 51.2 predicted in a Reuters poll. Anything above 50 indicates growth.

German 10-year bond yields, which had been as low as -0.695%, ticked up to -0.651% after the data.

Germany's 30-year bond yield also rose and was last up three basis points at -0.144%. Thirty-year debt sold for a record-low yield of -0.11% at an auction on Wednesday but raised only 824 million euros versus a target of 2 billion euros.

Italian government bond yields extended their declines early on Thursday after Reuters reported President Sergio Mattarella wanted clear signs of a possible deal to form a new government by the end of the day.

At 0730 GMT, 10-year government bond yields fell 5 basis points to 1.286%, its lowest in almost three years. Short-dated bond yields fell as much as seven basis points and Italy's 10-year spread over top-rated Germany fell to 195 bps, its narrowest July 29. OVERNIGHT FED Investors were also parsing minutes of the Federal Reserve's last meeting, which showed the Fed was divided over how to respond to slowing growth in the U.S. economy. Most policymakers favoured leaving rates unchanged.

They were united in wanting to signal they were not on a preset path to more cuts, a message not likely to sit well with U.S. President Donald Trump.

"The point is there are a lot of differing views, but that is where the parallels end," said Michael Leister, rates strategist at Commerzbank.

"For the ECB it is the design of the overall package; there are so many options. For the Fed there is only how much to cut and when to cut."

Global central bankers meet at Jackson Hole, Wyoming, for their annual gathering on Friday, and markets will be looking for any signals from there.

Attention is also turning to the bloc's fiscal response, after reports the Dutch government is considering pouring billions of euros into a new investment fund to finance future infrastructure and education projects.

(Reporting by Virginia Furness; editing by Raissa Kasolowsky, Larry King)