CORRECTED-UPDATE 1-Dovish ECB prompts second week of Italian-German spread tightening

(Corrects last paragraph to say German yield was two, not one year high)

* Italy/Germany 10-year yield spread at tightest in two weeks

* Italy to sell 5.5-6.5 bln euros of bonds in auction

* German yields up ahead of U.S. Core PCE data

* Euro zone periphery govt bond yields

LONDON, May 28 (Reuters) – The gap between Italian and German bond yields was at its narrowest in a fortnight on Friday and an Italian bond auction sailed through as the promise of further European Central Bank largesse helped fuel demand for Italian debt.

Italy sold 6.5 billion euros of five- and 10-year bonds, the maximum amount targeted, helped by the dovish tone of recent ECB comments.

After a prolonged selloff of Italian debt in recent months, Rome’s borrowing costs were set to drop for the second week running.

With euro zone countries having racked up debt to combat the economic impact of the COVID-19 pandemic, ECB support could prove crucial, especially for countries such as Italy that came into the crisis with a heavy debt load.

“The trend of (spread) tightening should continue as ECB dovishness feeds more into market pricing ahead of their next meeting,” analysts at Mizuho said in a note.

Italian 10-year yields dropped slightly on the day to 0.93%, down 10 basis points this week so far.

The closely-watched Italy-Germany 10-year bond yield spreads hit their tightest levels in over two weeks at around 110 basis points.

ECB President Christine Lagarde said on May 18 that the ECB remains committed to shielding the euro zone economy as the path of the coronavirus pandemic remains uncertain, and authorities should not withdraw support too soon.

Italy’s 10-year yields had risen to 1.16% before those remarks, but soon afterwards fell back below 1.00%.

Beyond Italy, euro zone yields were broadly unchanged ahead of the release of the Core PCE Price Index in the United States at 1230 GMT.

This is the U.S. Federal Reserve’s “favourite inflation metric”, according to Charalambos Pissouros, senior market analyst at JFD Group, and should provide further clues on rising inflation in the world’s largest economy.

German 10-year yields were flat at -0.174%, still comfortably off their recent two-year high of -0.074%.

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