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UPDATE 1-Italy boost lifts European markets off lows

Amy Caren Daniel and Medha Singh

* Italy's PD, 5-Star on verge of govt deal

* STOXX 600 set to extend 3-day losing streak

* London under-performs; investors return from long weekend (Adds comment, updates prices)

Aug 27 (Reuters) - European markets eased off their lows on Tuesday, as Italian stocks rallied on hopes that a snap election could be avoided by an arrangement to form a new government in Rome.

Milan's FTSE MIB rose 0.7% as the ruling 5-Star Movement and the opposition Democratic Party (PD) appeared on the verge of a deal after the PD indicated it had abandoned a veto on Giuseppe Conte serving another term as prime minister.

"Markets are pricing in the prospect that we might not see new elections," said Michael Hewson, chief market analyst at CMC Markets in London.

"Personally, I think any collaboration would in all likelihood be highly unpopular, and while it would keep the party in power in the short term, it would in all probability guarantee their electoral demise in the long term."

The pan-European STOXX 600 index was down 0.09% by 0805 GMT after paring losses of almost 0.3%, with London's FTSE 100 index slipping 0.4%.

British stocks - HSBC Holdings Plc, British American Tobacco and AstraZeneca - fell between 0.3% and 1.3%, and were the biggest drags on the STOXX 600.

Worries that major economies are on the brink of a recession has put the European market on pace to end August about 4% lower, but hopes that major central banks and governments would step in to counter the impact of trade war limited losses.

Heightened U.S.-China trade tensions drove a near 0.6% fall initially on Monday, but stocks stabilized to close marginally lower after U.S. President Donald Trump predicted a trade deal with China.

"There is noise about a slightly more emollient tone from President Trump towards China, but nothing has really changed. They've retaliated, the ante has been upped and things have gotten worse than where we were a week ago," said Hewson.

In a bright spot, Flughafen Zuerich rose about 4% and was the biggest gainer on the STOXX 600, after the Zurich airport operator posted better-than-expected first half results. (Reporting by Amy Caren Daniel and Medha Singh in Bengaluru; Editing by Bernard Orr and Arun Koyyur)