UPDATE 1-Italy's 2-year bond yield lowest since coalition came into power

Short-dated Italian bond yields hit their lowest level in seven months ahead of Thursday's European Central Bank meeting at which policymakers are expected to provide detail on a new round of cheap loans that should benefit Italian lenders. The ECB will also slash growth forecasts and is likely to provide its strongest signal yet that fresh stimulus is coming, hoping to stop an unexpected slowdown from becoming a downturn.

"There are a number of supportive factors for Italy these days, probably the most important one is the TLTROs," said Commerzbank rates strategist Christoph Rieger, referring to the official name for the ECB loans: targeted long-term refinancing operations. "Also earlier this week, we saw positive data (from Italy) for a change, plus we keep getting stories about new elections and (far-right League leader Matteo) Salvini taking over - something the market seems to like," he added.

Anticipation for these cheap loans have supercharged a rally in Italian debt, though it began in earnest when data this week showed that the Italian economy may be recovering better than expected after slipping into recession last year. Italy's two-year bond yields hit 0.198 pct in early trade on Thursday, before settling at 0.23 percent, still down 4 basis points on the day.

At this level, it is at its lowest since late May, just before Prime Minister Giuseppe Conte was sworn in to head a coalition of anti-establishment parties, the 5-Star Movement and the League, fuelling worries about the country's spending plans and future within the single currency bloc. Italy's 10-year bond yield dropped to a new five-week low of 2.58 pct, down 3 basis points on the day, while the closely-watched spread over Germany was at 248 bps.

Other euro zone bond yields were mostly flat ahead of the ECB meeting after having fallen on Wednesday. Germany's 10-year bond yield, the benchmark for the region, was unchanged at 0.13 percent. Also later on Thursday, France and Spain are due to hold bond auctions. France is to auction a new 10-year bond and tap its outstanding notes maturing in 2034 and 2045 to raise a total of 8 billion-9.5 billion euros.

Spain will sell up to 4.5 billion euros of bonds of varying maturities, including an inflation-linked note. (Reporting by Abhinav Ramnarayan Editing by Tommy Wilkes and Peter Graff)

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