Italian bond yields edge higher as ECB bias, bank rescue cloud picture

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

By Abhinav Ramnarayan

LONDON, July 5 (Reuters) - Investors were scrutinising the outlook for Italian bond yields closely on Wednesday after the European Central Bank bought more of that country's debt than usual in its flagship asset-buying program.

The ECB bought more than two billion euros of Italian and French bonds than it was supposed to in June, moving further away from a rule aimed at ensuring that its stimulus is evenly spread across the euro zone.

The conflict for investors is that Italy, seen as one of the biggest beneficiaries of the ECB's bond buying scheme, is expected to be amongst the losers as the central bank unwinds extraordinary stimulus.

However, if the ECB is going to buy more Italian bonds than expected in the months to come, this could soften the blow.

"It is very hard as an investor to know whether to buy or sell on this news," said DZ Bank strategist Christian Lenk.

"At the end of the day, if the ECB is approaching its limit of Bunds (it can buy), we may see a stronger deviation towards BTPs. But it is still a relatively small amount of deviation so far and the overall picture is of tightening."

Italy's 10-year government bond yield edged higher by a basis point to 2.12 percent on Wednesday.

However, the spread over German equivalents is only slightly off the tightest level all year at 164 bps, and more than 40 bps tighter than the April peaks.

It also emerged Tuesday that the European Union had approved a 5.4 billion euro state bailout of Italy's fourth-largest lender, Monte dei Paschi (Milan: BMPS.MI - news) di Siena, taking the total amount of Italian taxpayer funds deployed to rescue banks over the past week to more than 20 billion euros.

Euro zone government bond yields have been rising across the board in recent weeks on comments from policymakers that suggest the ECB is moving towards normalising its ultra-loose monetary policy stance.

Though some policymakers have since sought to play down this, German government bond yields are close to their highest levels all year at 0.48 percent.

Minutes of ECB's June meeting are due on Thursday, which should provide further clues on how far the tapering debate has gone in Europe.

The U.S. Federal Reserve is also due to publish minutes of its June 14 meeting later on Wednesday, with analysts waiting to see if the central bank drops any clues on whether it will push its next planned rate hike to later in the year.

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(Reporting by Abhinav Ramnarayan; Editing by Toby Chopra)