By Virginia Furness
LONDON, Feb 25 (Reuters) - Italian government bonds outperformed the broader euro zone market on Monday, with yields dropping by as much as 12 basis points after Fitch affirmed Italy's credit rating at BBB.
President Donald Trump's delaying of an increase in U.S. tariffs on Chinese goods following "productive" trade talks also boosted support for riskier assets and saw German government bond yields pull away from last week's lows.
The rally in Italian government bond yields cancelled out a sell-off on Friday ahead of Fitch's review.
Fitch affirmed Italy's rating with a negative outlook to reflect "the extremely high level of general government debt and the absence of structural fiscal adjustment" as well as "uncertainty arising from the current political dynamic."
A downgrade would have put Italy just one notch above a sub-investment grade rating, which investors fear because it could trigger forced selling by funds only able to buy investment grade bonds.
"Both effects contributed to the movement, but clearly the rating decision by Fitch is the most important one," Sebastian Fellechner, rates strategist at DZ Bank, said.
Italy's 10-year government bond yield was down nine basis points at 2.765 percent, having touched a low of 2.75 percent, which had pushed its spread over higher rated Germany to a three-week low of 259.5 basis points.
Short-end Italian government bonds also outperformed with two- and five-year yields last down 12 basis points to 0.41 percent and 1.715 percent respectively.
The rally was fuelled by the 5-Star Movement, one of the two parties in Italy's ruling populist coalition, losing in the Sardinia elections, while the centre-right gained, Commerzbank analysts said.
Elsewhere, core euro zone government bond yields rose after apparent progress in the U.S.-China trade talks boosted appetite for riskier assets.
Germany's 10-year government bond yield, the benchmark for the region, was up a basis points to 0.11 percent, while other 10-year yields in the bloc were flat to slightly higher on the day.
"Bunds remain confined around 10 basis points as there is this conviction that a couple of bits of positive news is not enough to derail [the downward pressure on yields]," Michael Leister, rates strategist at Commerzbank, said.
Trump's decision to delay an increase in tariffs on Chinese goods drove European shares to their highest since October as carmakers and mining firms rose..
Reporting by Virginia Furness, Editing by Tommy Wilkes, Gareth Jones and Alexander Smith