UPDATE 1-Euro zone bond yields edge down as sentiment stabilises

* Euro zone yields 1-2 bps lower across the board

* California rolls back reopening plans

* ZEW, industrial production releases due

* Italy to sell up to 10 bln euros of debt

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

By Abhinav Ramnarayan and Elizabeth Howcroft

LONDON, July 14 (Reuters) - Investors retreated to safe euro zone government bonds on Tuesday after a surge in COVID-19 cases in California dampened Monday's excitement over improved corporate earnings.

The most populous U.S. state announced new restrictions on businesses on Monday and its two largest school districts, Los Angeles and San Diego, said children would be made to stay home in August.

"California rolling back its reopening plan late yesterday shows markets still have to deal with the fallout from record U.S. case counts," ING rates strategist Padhraic Garvey said in a note.

Most euro zone bond yields were about 1-2 basis points lower, with the market relatively stable as investors focused on the European Central Bank meeting on Thursday and EU summit at the end of the week, at which leaders will discuss the proposed EU-wide recovery fund.

Germany's 10-year Bund yield - the benchmark for the region - dropped around 1 basis point to -0.419%, with slightly bigger drops at the longer end of the curve .

The fall cancels out some of Monday's 6.3 bps rise, the biggest daily gain in over a month and coming on the back of a stock market rally. That fizzled out towards the end of the U.S. session, however, with the S&P 500 ending the day down 1%.

The change in risk sentiment was also fuelled by a further potential deterioration in trade relations between the United States and China, analysts said.

The Trump administration plans to scrap a 2013 agreement between the two countries' auditing authorities, a move that could foreshadow a broader crackdown on U.S.-listed Chinese firms, an official told Reuters.

Riskier southern European yields also dipped, with the Italian 10-year yield at 1.301% and Spain's 10-year yield down 2 bps at 0.435%.

Rabobank rates strategist Richard McGuire said that moves on Tuesday were limited by thin trading volumes as markets enter an early summer lull.

"Investors will probably be hunkered down now given the potential for the developments – possibly notable developments – on Thursday and Friday, even though both of these may potentially be non-events," he said.

German Chancellor Angela Merkel said on Monday she could not guarantee that EU member states would reach an agreement on the 750 billion euro coronavirus recovery fund and a multi-year budget at the summit this week.

If the ECB does not take further action immediately and EU leaders dither over finalising details of a recovery fund for the bloc, investors could end up disappointed, ING's Garvey added.

Italy sold 10 billion euros of bonds due in 2023, 2027 and 2040 in an auction.

(Reporting by Abhinav Ramnarayan and Elizabeth Howcroft; editing by John Stonestreet and Nick Macfie)