UPDATE 2-German 10-year yield at 7-week low as inflation lags

* Euro zone periphery govt bond yields (Adds data of Italian auction)

AMSTERDAM, Sept 29 (Reuters) - The 10-year Bund yield hit its lowest in over seven weeks on Tuesday as Germany’s inflation reading missed forecasts ahead of a reading for the euro zone while divisions widened between policymakers on how to react to a second COVID wave.

September’s harmonised German consumer prices fell 0.4%, far below the 0.1% drop analysts had expected. Euro zone inflation data is due on Friday.

Hawkish European Central Bank policymakers argue the bank is playing down good news from economic indicators, while dovish ones are pushing ECB President Christine Lagarde to adopt stronger language on the risks to growth and the threat from the euro’s appreciation.

“It’s really missed expectations...The lower the inflation rate goes, the better hand (dovish policymakers) have,” said Rene Albrecht, strategist at DZ Bank. He said he did not expect fresh stimulus at the bank’s October meeting, ahead of the U.S. presidential election on Nov. 3.

German bonds reacted slightly to the national inflation data, which followed regional readings.

The 10-year yield was near seven-week lows touched in earlier trade at -0.541%, down 1.6 basis points on the day.

Italian government bond yields dropped after Italy sold the top planned amount of 8.25 billion euros at a bond auction on Tuesday, placing 2.5 billion euros of a five-year BTP bond at a 0.35% gross yield, the lowest level since January.

Italy’s 10-year Btp yield fell 4 basis points to 0.791%.

A key market gauge of long-term inflation expectations in the euro zone rose off its lowest since July to 1.14%, - off the ECB’s target of close to, but below 2%.

There was also some focus on the ECB’s weekly bond purchase data released late on Monday, which showed buying under its emergency pandemic purchase programme increased marginally to its highest since late July.

“The data suggests that the hawks on the governing council may not have succeeded in their aim to tacitly keep purchases lower,” Christoph Rieger, head of rates and credit research at Commerzbank, told clients.

In the primary market, Italy raised 8.25 billion euros in an auction of five-, 10-year and floating-rate bonds, while Finland raised 1 billion euros from a bond due 2036. (Reporting by Yoruk Bahceli with additional reporting by Stefano Rebaudo Editing by Mark Heinrich)