* Italian bond yields fall ahead of budget proposal
* Salvini says budget meeting went well
* Di Maio denies he had threatened to pull his party out of govt
* German bond yields fall, pull back from 3-month highs (Updates prices, adds market reaction to Brexit headlines)
By Virginia Furness
LONDON, Sept 21 (Reuters) - Italian bond yields fell on Friday as investors awaited clarity on the 2019 budget and after the 5-Star Movement denied a report that Deputy Prime Minister Luigi Di Maio had threatened to pull his party out of the government.
A report by the national statistics institute ISTAT that the budget deficit as a proportion of national output was slightly higher last year than previously estimated but that debt was lower also helped to push down yields.
German bond yields extended falls after British Prime Minister Theresa May said Brexit talks with the European Union had reached an impasse, sparking a sell off in sterling and boosting demand for safe-haven assets.
In Italy, Prime Minister Giuseppe Conte met his top ministers to try to overcome an impasse over the government’s first budget between the ruling parties and the economy minister who is resisting their plans to boost spending.
Italian bond yields were down up to 7 basis points across the curve, having jumped by up to 12 bps on Thursday on a news agency report that Di Maio had threatened to quit the coalition if his party’s spending demands were not met., ,. The denial by his spokeswoman came later that day.
The government parties remain keen to spur economic growth by setting next year’s budget deficit target at more than two percent of annual output, a level that clashes with European Union commitments and may boost the country’s mammoth debt.
Economy Minister Giovanni Tria, who is a member of neither party, has to set growth, deficit and debt targets for next year’s budget by Sept. 27. Tria wants to keep the 2019 deficit at 1.6 percent of GDP, according to a government source, while sources from the 5-Star and League have told Reuters they want it as high as 2.5 percent.
Outside Italy, most euro zone bond yields were lower on Friday.
PMI data showed euro zone business growth eased again in September, another sign momentum in the currency bloc is well past its peak.
Germany’s 10-year bond yield was down 2 bps at 0.46 percent as investors returned to safe-haven assets. It had hit a four-month high of 0.506 percent on Thursday.
Higher Japanese government bond (JGB) yields are putting upward pressure on the 10-year Bund yield and could push it above 0.50 percent again, said Mizuho rates strategist Peter Chatwell.
“A catalyst could be the rise in long end JGBs after this morning,” he said. “The 40-year JGB is now over 1 percent and that was the ceiling for a long time. Demand for Bunds will be at a slightly higher level now.”
Long-end Japanese government bond yields rose on Friday after the Bank of Japan opted to reduce long end purchases by 10 billion yen at its latest policy meeting. Forty-year JGB yields breached 1 percent. (Reporting by Virginia Furness Editing by Matthew Mpoke Bigg)