Italy's borrowing cost spread with Spain widens to near post-crisis high

* Worries over early elections, ECB withdrawal hit Italian bonds

* Italy-Spain yield spread near its widest since 2012 crisis

* Spanish resolution of failing bank contrasts with Italian woes

* Euro zone periphery's bond yields http://tmsnrt.rs/2ii2Bqr (Updates prices, adds quotes )

By Abhinav Ramnarayan

LONDON, June 7 (Reuters) - The difference between Italy's borrowing costs and those of its closest peer neared its widest on Wednesday since the euro zone's debt crisis of 2011-2012, underlining its status as one of the region's most vulnerable markets.

The gap (Frankfurt: 863533 - news) between Italy's 10-year bond yields and similarly rated Spain's widened as investors focused on Italy's lack of progress in stabilising its troubled banks, the political risk for Rome of snap elections and the possible winding down of monetary stimulus by the European Central Bank.

The European Commission on Wednesday approved a sale of Spain's Banco Popular to keep it from falling into insolvency[. But in Italy, state aid is the only option being considered for two ailing Veneto-based banks .

"In Spain, the banking issues are viewed as localised, whereas in Italy they still have to resolve the problem," said David Owen, chief European financial economist at Jefferies.

"And then if you get early Italian elections and ECB tapering, you can see a scenario where spreads widen out even further."

The Italian 10-year yield spread over Germany, the benchmark for the region, widened to 203 basis points, the biggest gap 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 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.

With Italy's debt agency holding a sale of 30-year bonds, benchmark 10-year debt yields rose 4 basis points on the day - underperforming euro zone peers.

"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.

Italy's Constitutional Affairs Committee on Monday signed off on a new electoral law after the main parties reached an agreement that may lead to a national election this autumn .

In addition, the ECB meets on Thursday and is widely expected to rule out the introduction of further stimulus . Italy is one of the biggest beneficiaries of the ECB's current ultra-loose policy.

Most other euro zone bond yields were a touch higher, having briefly dipped after Bloomberg reported the ECB was preparing to cut its inflation forecasts at this week's policy meeting .

German Bund yields dipped to a six-week low of 0.25 percent but was trading flat in late trade.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

(Additional reporting by John Geddie and Dhara Ranasinghe; Editing by Larry King)