UPDATE 1-German 10-yr bond yields hits seven-week high, 0.5 pct in sight

Germany's 10-year government bond yield rose to a seven-week high on Wednesday, pushing closer to the key 0.50 percent mark ahead of a three billion euro sale of long-dated German debt later in the day.

New bond supply often puts upward pressure on yields, with investors selling existing bonds to make way for new ones.

The sale takes place not just against a backdrop of hefty supply in the euro area this week but also souring sentiment towards bonds in Germany, the euro zone's biggest economy and its benchmark bond issuer.

Growing confidence that Italy's new anti-establishment government will deliver a budget that respects European Union rules on fiscal discipline have boosted Italian bonds and prompted investors to unwind safe-haven flows into German debt.

A rally in world stock markets and expectations for another rise in U.S. interest rates next week have also pushed up yields in the world's biggest bond markets -- U.S. 10-year Treasury yields are trading near four-month highs, back above 3 percent.

"There are three factors at play here -- one is the Italian market and when there are tighter spreads and lower Italian yields, that means higher Bund yields," said Commerzbank rates strategist Christoph Rieger.

"The second factor is the bearish momentum in U.S. Treasury yields and the third is supply."

The German 10-year Bund yield rose to 0.49 percent, its highest level since Aug. 1, and within striking distance of the 0.50 percent mark which analysts say has proved a key technical barrier in the past.

It is up around 3.5 bps this week and 15 bps this month.

"If the risk-on environment continues to prevail, they (Bund yields) could easily test the 0.50 percent threshold which has never been broken since the end of May," analysts at UniCredit said in a note.

Italian bond yields continued to edge lower on Wednesday, with 10-year bond yields down 1 bp at 2.78 percent -- leaving the gap with German 10-year bond yields at 228 bps and close to its narrowest in about a week.

While optimism about Italy's budget has grown, analysts say the Italian bond market remains sensitive to the headlines coming out from Rome.

The 5-Star Movement and League, the two parties making up Italy's coalition, are expected to hold a joint news conference on measures to simplify taxation and support the real economy later in the session.