June 28, 2018 / 3:07 PM / 10 months ago

UPDATE 2-Italy passes auction test as trade tensions grip wider markets

* Italy sells 6.5 bln euros of bonds, soothing concerns

* Most euro zone yields lower on trade tensions

* Spanish, some German state inflation exceed 2 pct

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

By Abhinav Ramnarayan

LONDON, June 28 (Reuters) - Italy sold 6.5 billion euros of government debt on Thursday, batting away concerns that recent political ructions would hamper its ability to borrow money in bond markets.

On a day when bond yields across the euro zone fell on global trade tensions, the euro zone's third largest economy issued three bonds, placing the top targeted amount in a 5-6.5 billion euro range.

"The bid-to-cover ratio is a bit below average but the size is at the high end, which I think is very encouraging," said UniCredit fixed income strategist Luca Cazzulani.

"There is a wide range of factors that is helping, including the fact that the discussions (at government level) are moving to a more normal set of topics," he said.

In secondary trading, Italian government bond yields rose slightly just after the auction as investors absorbed the new supply, only to fall back by late trade with euro zone peers.

Italy's 10-year bond yield was last down 3 bps at 2.80 percent.

Deutsche Bank's asset management arm DWS is looking to buy Italian bonds at wider spreads and is confident Italy will not seek to exit the European Union, its head of fixed income for Europe, Middle East and Africa, said on Thursday.

The Italian bond market has been hammered in recent weeks on fears a coalition between anti-establishment parties will embark on high-spending policies and hinder euro zone integration with a hard line on the single currency.

But a prominent League eurosceptic senator told Reuters on Wednesday that Italy's new government would do nothing to undermine the euro and investors have no reason to fear its agenda.

"The general tone from the Italian government has been a little bit more conciliatory, which has given markets some comfort that the budget deficit should stay under control," said DZ Bank analyst Andy Cossor.

Other euro zone government bond yields fell 1-4 bps as global trade tensions hit stock markets - the pan-European stock index slipped 1 percent - boosting the appeal of fixed income.

Germany's 10-year bond yield edged lower to 0.31 percent, only a shade off recent one-month lows.

The demand for bonds is particularly noticeable against the backdrop of rising inflation - usually a cue for selling bonds.

Italian consumer prices accelerated to 1.5 percent from 1 percent in May, data showed on Thursday. Data from Germany showed inflation there surpassed the ECB's near 2 percent target in June. Spanish consumer prices rose in June at their fastest rate since April 2017, as fuel costs pushed inflation above 2 percent for the second month running.

There was also some focus on a European Union summit that could prove disruptive to bond markets as German Chancellor Angela Merkel seeks a continent-wide agreement on migration, an issue that is threatening her governing coalition. (Reporting by Abhinav Ramnarayan Editing by Jon Boyle and Andrew Heavens)

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