* Italian 10-year bond yields at 7-week low
* Outperform euro zone peers
* Risk appetite, ECB policy, summer carry trades help
* Fed’s Powell talks up U.S. economy outlook (Adds Powell testimony, updates prices)
By Dhara Ranasinghe
LONDON, July 17 (Reuters) - Italy’s long-term borrowing costs fell to seven-week lows on Tuesday, narrowing the gap over euro zone benchmark issuer Germany in a recovery for the country at the centre of a bond market rout in late May.
Analysts cited a number of reasons for the rebound, including a pick-up in risk appetite globally and confidence that the European Central Bank will keep rates on hold for some time.
Italian government bond yields were down 10-12 basis points across the curve, on a day where most euro zone yields were just 2-3 bps lower.
“The idea is that the market is in risk-on mode unless told otherwise,” said Richard McGuire, head of rates strategy at Rabobank in London.
“Both stocks and peripherals are positive in the absence of any negative news, so these risky assets are doing well.”
Italy’s 10-year bond yield fell more than 10 bps to 2.48 percent, its lowest level in seven weeks, and down from a peak of around 3.39 percent hit briefly on May 29 as Italian political turmoil gripped markets.
The gap over the benchmark German Bund yields was 212 bps - its tightest since early June. Two-year Italian bond yields fell more than 10 bps to 0.55 percent, the lowest in around a month, before settling at 0.57 percent.
Analysts said the ECB’s signalling last month that it would keep interest rates in the euro area at record lows well into next year also helped explain the rebound in Italian bonds.
They added that the market-friendly rates backdrop was encouraging carry trades, where investors borrow in a country with low interest rates and park the cash in higher yielding assets such as Italian debt.
“We’ve also noted the latest bullish dynamics in Italy, which started with the ECB conference last month,” said Rainer Guntermann, a rates strategist at Commerzbank.
“Despite some still notable headline noise from the political landscape, it seems that the political story has been taken on board and is not creating additional weakness for now.”
Ratings agency DBRS on Friday confirmed Italy’s rating at BBB (High) and said that expected deviations from current fiscal targets under the new coalition government were unlikely to materially undermine its public debt sustainability.
Across the Atlantic, Federal Reserve Chair Jerome Powell said in his testimony to Congress that the world’s largest economy is on the cusp of “several years” where the job market remains strong and inflation stays around the Fed’s 2 percent target.
Given that his views support the Fed’s rate hike path even in the face of concerns over a trade war, this pushed U.S. Treasury yields slightly higher on the day, though not quite enough to have an impact on the euro zone bond market.
Germany’s 10-year bond yield, for example, was set to close the day 2 bps lower at 0.35 percent.
The euro zone’s largest economy earlier sold 2.4 billion euros of two-year Schatz bonds.
Reporting by Dhara Ranasinghe Editing by Gareth Jones and Ken Ferris