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UPDATE 2-Euro zone bond yields flat, Italy's new issuance in focus

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds background)

LONDON, April 7 (Reuters) - Euro zone bond yields were flat on Wednesday, with southern European debt stabilising after a sell-off in the previous session as markets braced for new supply from Italy and Portugal.

Italy started the process of selling new 50-year and 7-year bonds via a syndicate of banks on Wednesday, having flagged the new issues the previous day.

Portugal raised, via a syndicate of banks, 4 billion euros from a 10-year bond on the back of 30 billion euros of demand, according to a lead manager memo.

The tone across euro zone debt markets was largely subdued, with most 10-year bond yields down 1-2 basis points (bps) on the day following an overnight fall in U.S. Treasury yields.

“Overall, the pull higher from U.S. rates is alive and well and the rebound in euro zone bond markets is largely technical and temporary in nature,” said senior ING rates strategist Antoine Bouvet.

Germany’s 10-year Bund yield was flat at -0.32%, down from recent highs around -0.26%.

IHS Markit’s euro zone Services Purchasing Managers’ Index (PMI) rose to 49.6 in March from February’s 45.7, higher than a flash estimate of 48.8 and only just shy of the 50 mark that separates growth from contraction.

The euro zone economy is on course for a robust recovery in the second half of the year that could allow the European Central Bank to start phasing out its emergency bond purchases in the third quarter, Dutch central bank chief Klaas Knot said.

The ECB bought a net 6.178 billion euros ($5.20 billion) of assets last week as part of its quantitative easing programme, below the 23.995 billion euros it purchased a week earlier.

Italy’s 10-year bond yield was unchanged at 0.70% , having risen sharply on Tuesday as investors braced for new supply. The gap over German Bund yields held just above 100 bps.

Analysts said bond spreads were moving back into focus, especially after a decision by the German constitutional court last month to stop the ratification of the European Union’s Recovery Fund prompted investors to price some risk back into peripheral bonds.

“The Tesoro’s (Italian Treasury’s) announcement of a new syndicated 50-year BTP caught markets off guard, with 10-year and 30-year (yield) spreads versus Bunds widening up to 7 bps to the highest level in almost a month,” said Michael Leister, head of interest rate strategy at Commerzbank, referring to Tuesday’s market moves.

“While thinner Easter liquidity might also play a role, these moves add weight to our tactical shorts in Italy versus semi-core (bonds) and Spain as supply indigestion risk is being compounded by doubts regarding the NGEU (Next Generation EU), the ECB’s resolve and less generous carry differentials.” (Reporting by Dhara Ranasinghe; Additional reporting by Yoruk Bahceli; Editing by Pravin Char)

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