Spain, Italy yields drop as ECB hints at bond purchase adjustments

* Spain, Italy bond yields fall to two-week lows

* Highly (Shanghai: 600619.SS - news) -indebted countries seen as benefiting from tweaks

* German-U.S. spread near 3-week high on policy divergence

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Recasts and writes through)

By John Geddie and Abhinav Ramnarayan

LONDON, Feb 16 (Reuters) - Investors bought up bonds of highly-indebted euro zone states like Italy and Spain on Thursday after the European Central Bank kept the door open to changing the proportion of bonds they buy from each country if market conditions change.

Minutes from the ECB's meeting on Feb. 17 said "limited and temporary" deviations from the so-called capital key - a system used to buy bonds based on the size of a country's economy - "were possible and inevitable".

The ECB has already been deviating from the capital key in Ireland (Other OTC: IRLD - news) and Portugal, where it is running out of bonds to buy.

Investors took the latest comments as a signal that it may favour highly-indebted countries over Germany, where the lion's share of its purchases have been focused so far.

Yields on Spanish and Italian 10-year bonds fell more than 10 basis points to two-week lows of 1.59 percent and 2.14 percent, respectively. Portuguese equivalents fell over 10 bps to around 4 percent.

Benchmark German 10-year bond yields fell 3 bps to 0.35 percent

"The market move clearly came after the minutes and this suggestion that the ECB is looking at ways, if they feel they need to, to tweak the capital key," Credit Agricole (Swiss: ACA.SW - news) strategist Orlando Green said.

"That potentially gives the countries that have the most debt more of a boost."

The main takeaway from the ECB minutes was that there appears to be little appetite to curb their monetary stimulus while Europe gears up for high-stakes elections.

This contrasts with the United States where policymakers seem set on tightening policy in the coming months and data showed U.S. inflation recording its biggest gain in nearly four years.

Illustrating this divergence, the spread between U.S. and German benchmark government bond yields was close to a three-week high on Thursday at 211 bps.

"The consolidation in the transatlantic spread has ended with the hawkish talks from the U.S.," said DZ Bank strategist Daniel Lenz. "Meanwhile tapering talk in Europe has faded with the ECB stating that it is not on the agenda and political risks keeping it from rising too much."

The U.S.-German bond yield spread has been noticeably wider since the election of Republican Donald Trump as U.S. president fuelled expectations of higher growth and inflation in the world's richest country.

Political concerns in Europe have centred on France, with a presidential election coming up in April and May, but the country's debt agency on Thursday sold over 7 billion euros of bonds in an auction, with demand topping 14 billion euros.

Also, Spain sold 4.5 billion euros ($4.8 billion) of debt at an auction on Thursday, including a tap of its 10-year benchmark bond.

(Reporting by Abhinav Ramnarayan; Editing by Tom Heneghan)