Italian bond yield gap over Spain near widest since debt crisis

* Worries over early elections, ECB withdrawal hit Italian bonds

* Italy-Spain bond yield gap close to widest since 2012 crisis

* Spanish resolution of failing bank contrasts with Italian woes

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, June 7 (Reuters) - The gap (Frankfurt: 863533 - news) between Italian and Spanish 10-year bond yields was heading towards its widest level since the 2012 debt crisis on Wednesday, as investors fretted over possible early elections and the effect of tighter policy on Italian borrowing costs.

The similarly-rated Southern European neighbours are often compared in the bond market, and the difference in their government bond yields used as a measure of risk in the bloc.

As the Italian debt agency prepared to sell 30-year bonds later in the day, Italy's benchmark 10-year debt underperformed the rest of the euro zone bond market.

While the bond sale may have marginally exacerbated the effect, Italian yields have been rising in recent weeks on political worries, expectations of a move away from extraordinary European Central Bank monetary stimulus and concerns over banking system.

"The Italian long-end spreads are being hit by the 30-year deal, but overall it's more the focus on politics that is making the bonds weaker," said ING strategist Benjamin Schroeder.

"The Italian parliament is voting on a new electoral system which means we could have elections in September - that could coincide with the ECB's timeline for normalising its policy," he said.

Italy's Constitutional Affairs Committee on Monday signed off on a new electoral law after the main parties reached a deal which could pave the way for a national election in the autumn.

In addition, the ECB meets on Thursday and is widely expected to take a small step towards normalising policy by ruling out the introduction of further stimulus.

Italy is seen as one of the biggest beneficiaries of the ECB's current ultra-loose policy.

Most high-grade euro zone bond yields were unchanged, but lower-rated southern European bonds underperformed, their yields rising 2-3 basis points.

The Italian 10-year yield spread over Germany -- the benchmark for the region -- hit 201.7 basis points on Wednesday, the widest since April 21.

The Italy-Spain bond yield spread, at 74 bps, was just 1 basis point off its March peak, when the gap was at its widest since the euro zone debt crisis in February 2012.

The move came after the European Commission approved the sale of struggling Spanish lender Banco Popular to Santander as a way of preventing Popular (NasdaqGS: BPOP - news) going into insolvency.

The quick resolution of this banking issue contrasts sharply with Italy, where several banks are struggling with a bad loans crisis. Rescue proposals are yet to be approved because they may transgress rules preventing a state bailout of banks. The rescue of Banco Popular did not involve state aid.

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(Reporting by Abhinav Ramnarayan, editing by Louise Heavens)