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UPDATE 1-Italy's 10-year bond yield hits record low on hopes new government is near

Dhara Ranasinghe and Yoruk Bahceli

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* Italy bond yields tumble

* 10-year BTP at a record low

* Finland expected to sell new 5-year bond

* Euro zone periphery govt bond yields (Updates with move in U.S. bonds, gilts, bond sales)

LONDON, Aug 28 (Reuters) - Italy's 10-year bond yield fell to a record low below 1% on Wednesday on growing hopes that a new government will soon be formed and new elections averted.

Broader euro area bond markets also rallied as a key part of the U.S. Treasury curve inverted further, fuelling recession fears.

In Italy, headlines pointed to a deal between the ruling anti-establishment 5-Star Movement and opposition Democratic Party (PD)to form a new government.

The head of the PD, Nicola Zingaretti, said he had accepted that Giuseppe Conte should return as the prime minister of a new government. Zingaretti will meet Italian President Sergio Mattarella at 1400 GMT.

"Our baseline assumption is that a green light will come for some kind of new government," said Chris Scicluna, head of economic research at Daiwa Capital Markets.

A new coalition government implied a "more sensible fiscal policy" in the near term, Scicluna said; the threat of a government led by the League's Matteo Salvini that would create conflict with the European Union would diminish.

Italian bond yields tumbled 10 to 14 basis points across the curve. Two-year bond yields fell to their lowest since May 2018 at -0.20%, 10-year yields hit a record low below 1% and Italy's 50-year bond yield fell to a record low around 2.31%.

But optimism over Italy failed to trigger selling of safe-haven German bonds as concern about the U.S./China trade war grew.

The U.S. Treasury yield curve - as measured by the gap between two and 10-year bonds - inverted the most since 2007 on fears the trade tensions will tip the economy into recession. The U.S. bond yield curve is widely regarded as a recession indicator.

In Japan, 30- and 40-year bond government yields hit three-year lows on Wednesday.

Germany's benchmark 10-year Bund yield dipped to -0.717% , nearing recent record lows of -0.727%.

"The rally in bonds in the U.S. and Europe is continuing because expectations for a trade deal are moving further away," said Antoine Bouvet, senior rates strategist at ING in London.

"The unpredictability of the trade conflict might push investors to price the worst outcome until they receive evidence that it can be avoided."

Renewed Brexit uncertainty supported safe-haven bonds -- five-year gilt yields falling to three-week lows on news that British Prime Minister Boris Johnson plans to restrict parliament's time before Brexit.

Elsewhere, Germany sold 2.336 billion euros of 10-year bonds later, while in Finland signs emerged of strong demand for a new five-year bond sold via a syndicate of banks. Orders for the new bond were nearly three times the targetted amount of 3 billion euros, according to lead managers.

(Reporting by Dhara Ranasinghe and Yoruk Bahceli; Editing by Andrew Heavens)