* Italy sells 6.9 billion euros of bonds
* Initial optimism over Greek deal give way to doubts
* IMF's Lagarde says no substantial results in Greek talks (Adds quote, updates prices)
By Emelia Sithole-Matarise and John Geddie
LONDON, May 28 (Reuters) - Italian bond yields held steady on Thursday after a debt sale in Rome saw strong demand though borrowing costs hit a five-month high in a cautious market after conflicting reports on the progress of Greek debt talks.
Italy sold 6.9 billion euros of five-, 10- and 17-year bonds, towards the upper end of a 5-7 billion euro targeted range, with the yield on the 10-year paper rising to its highest at auction since December 2014.
Strategists said the demand showed that investors were cautiously coming back to the market after weeks of violent price swings.
"It's one more stone in the wall of stability that we are building up now ahead of the summer," said Societe Generale strategist Ciaran O'Hagan.
Italian 10-year yields edged up slightly after the sale to 1.87 percent as markets digested the new supply, but the move was modest compared to their peripheral peers Spain and Portugal. Other euro zone yields were flat or 1-2 bps lower.
Greek bonds were the best performers, with yields down 16 bps at 11.11 percent, after Greek officials spoke optimistically of reaching a cash-for-reforms deal. Economy Minister George Stathakis said Greece and its international creditors had converged on key points.
That was immediately met by denials from European Union and International Monetary Fund officials.
IMF President Christine Lagarde said on Thursday there were no substantial results in talks with Greece so far. German Finance Minister Wolfgang Schaeuble said the same, adding he was surprised by the upbeat tone from some Greek government officials.
European Central Bank officials also played down prospects of any immediate loosening of funding for the country, raising uncertainty over whether Greece can get the support it needs to make payments to the IMF on June 5.
"Scepticism certainly remains warranted given Greece's track record in recent months of being overly optimistic," Commerzbank strategist Benjamin Schroeder said.
Spanish and Portuguese bonds were the worst performers, with yields rising 5 bps to 1.85 percent and 2.55 percent respectively.
Regional elections over the weekend confirmed the political landscape has fragmented in austerity-weary Spain, and a similar feeling is brewing among the electorate in its Iberian neighbour Portugal. Both countries will go to the ballot box later this year with neither looking likely to return an overall winner.
In a note to clients on Thursday, RBS recommended favouring Italian bonds over Spanish bonds, expecting the 3 bps gap between them soon to be wiped out. (Editing by Catherine Evans)