* Italy-Germany yield spread widens to 7-week high at 118 bps
* German yields dip for second day in a row
* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Adds details, updates prices)
By Abhinav Ramnarayan
LONDON, Jan 14 (Reuters) - The gap between Italian and German government bond yields was at its widest level in over a month on Thursday amid worries over the political ructions in Rome as the country grapples with an economic slowdown.
Italy's former premier Matteo Renzi pulled his small party out of government on Wednesday, stripping the ruling coalition of its parliamentary majority and triggering political chaos while the nation battles a resurgent COVID-19.
The Italia Viva party is "untrustworthy", the leader of the centre-left, co-ruling Democratic Party said, indicating he would not want to forge a new alliance with it.
A new election would likely be avoided by Prime Minister Giuseppe Conte, but political uncertainty will remain in the near future, analysts said.
"The Italian political crisis snaps the string of the relentless rally we have had since last spring (in Italian bonds). We could see a bit more widening in the coming weeks if the political uncertainty remains," said ING rates strategist Antoine Bouvet.
"That said, we are not expecting new elections and the ECB's purchase programme will put a lid on any massive moves," he added.
Italian government bond yields were last up between 4 and 6 basis points across the curve, with the benchmark 10-year bond yields up 6 bps to 0.62%.
The closely watched spread between German and Italian 10-year yields rose to as high as 118.4 bps, their highest in seven weeks and was last at 116.4 bps.
Italy also sold 9.25 billion euros in a bond auction on Thursday, potentially putting further upward pressure on yields. Yields tend to rise during large bond sales as investors sell outstanding debt to make space for the new supply.
The recent rise in Italian bond yields pushed up Italy's borrowing costs at the auction, which has cost the country 7.6 million euros according to Economy Minister Roberto Gualtieri.
After recording their biggest drop since Sept. 11 on Wednesday at 5.2 bps, German 10-year government bond yields, the benchmark for the region, fell another 3 bps to -0.55% on Thursday, their lowest in a week.
The moves on German Bunds run counter to other major government bonds around the world, where yields have been pushed up by the promise of a big stimulus package from U.S. President-elect Joe Biden.
U.S. 10-year Treasury yields were unchanged at 1.09% , pushing the gap between U.S. and German 10-year yields higher to 165 basis points.
Elsewhere, European Central Bank chief economist Philip Lane faced pushback from fellow policymakers at the ECB's latest meeting, as he wanted to let banks borrow even more at negative rates from the ECB, the bank's December meeting minutes showed.
While policymakers often disagree about policy moves, differences are usually resolved before the meeting, so the chief economist's proposal is rarely changed.
Rate setters were also at odds about the size of the additional emergency bond purchases the bank announced.
(Reporting by Abhinav Ramnarayan; Additonal reporting by Yoruk Bahceli; Editing by William Maclean and Lisa Shumaker)