UPDATE 4-Italian yields hover at 3-month lows as traders eye talks in Brussels

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Adds Cyprus pricing)

By Olga Cotaga and Yoruk Bahceli

LONDON, July 7 (Reuters) - Italian 10-year government bond yields clung to recent three-month lows on Tuesday as traders awaited signs of progress from talks this week in Brussels on a European recovery fund.

On Wednesday, German Chancellor Angela Merkel will travel to Brussels to discuss the fund, which investors hope will be provided in part as grants as proposed by the European Union executive, helping economic recovery in southern European states and easing worries they could be saddled with more debt.

"We currently have some thoughts and hopes that there could be a breakthrough concerning the recovery fund," said Daniel Lenz, rates strategist at DZ Bank.

Some European countries have raised concerns about the proposed grants, preferring the fund to be provided fully as loans. The European Commission is expected to release an updated proposal on the fund soon.

Italian 10-year BTP yields were down 2 basis points to 1.29% in late trade, not far from three-month lows hit last Friday at 1.25%.

German 10-year Bund yields were up 1 basis point to -0.43% , having touched earlier a six-day low of -0.457%.

Yields remained unchanged after the European Commission said the euro zone economy would drop deeper into recession this year and rebound less steeply in 2021 than previously thought.

Greek 10-year government bonds fell as low as 1.129% , their lowest since Feb. 26. Analysts said a euro zone agreement on new debt relief measures for Greece worth about 750 million euros ($840 million) helped the broader sentiment, but probably did not cause the fall.

Rainer Guntermann, rates strategist at Commerzbank, underlined the difficulty of interpreting day-to-day moves on Greek debt, given the uncertainty around how much the European Central Bank is buying on the day and the illiquidity of Greece's debt market.

"I don't think there was surprise in these measures," he said of the debt relief announcement.

In auctions, Austria sold 920 million euros in 10-year bonds and 460 million euros in 50-year bonds issues. Germany raised 585.4 million euros via a 10-year inflation-linked bond.

Cyprus raised 1 billion euros from the reopening of bonds due 2024 and 2040 via a syndicate of banks, receiving 5 billion euros of demand, according to a lead manager.

France hired a syndicate of banks for the sale of a 15-year inflation-linked bond, according to a lead manager. The deal will be launched "in the near future, subject to market conditions", a phrase usually used a day before a sale.

(Reporting by Olga Cotaga and Yoruk Bahceli Editing by Mark Heinrich)