By Ana Nicolaci da Costa
LONDON, Aug 5 (Reuters) - Italian bond yields fell on Monday to their lowest since mid-June after services data beat forecasts and comments from centre-right leader Silvio Berlusconi soothed investor concern about the fragile government.
Italy's services sector shrank in July at its slowest pace since going into a downturn in mid-2011, and euro zone business expanded for the first time in 18 months in July, surveys on Monday showed.
When the economic outlook brightens, investors tend to have more appetite for riskier assets.
Berlusconi supporters protested in Rome on Sunday against the former premier's tax fraud conviction but he said the coalition of his People of Freedom party and the centre-left Democratic Party of Prime Minister Enrico Letta must continue.
"There were fears that (Berlusconi) might attempt via his supporters to cause some problems and I think that political disruption has dissipated somewhat. Combined with the better data we are seeing in Europe, that is clearly helping sentiment in peripherals," Nick Stamenkovic, strategist at RIA Capital Markets said.
Ten-year Italian government bond yields fell 3 basis points to 4.26 percent, having dropped as far as 4.23 percent earlier. Equivalent Spanish yields were 1.2 basis points lower at 4.55 percent.
Italian bonds have largely weathered the rise in political risk thanks in part to the attractive yield they offer and the support from the European Central Bank's bond-buying programme.
Cash flow was also in Italy's favour. Barclays strategists expect Italian redemptions and coupon payments for the remainder of the year to be higher than the amount of bonds sold by 18 billion euros.
For all these reasons, investors are sticking with their Italian bonds for now.
Trade was choppy because of summer holidays in Europe. Despite signs of an improvement in the euro zone economy, a fall in retail sales in June underscored the precarious nature of the recovery.
Ten-year German yields held steady at 1.65 percent, having fallen on Friday when a weaker-than-expected U.S. jobs report pushed back some bets the Federal Reserve would start to withdraw U.S. stimulus in September.
U.S. non-manufacturing activity data later on Monday will be scoured for any fresh signals on when "tapering" might begin, analysts said.
"People are paying a lot of attention to all of the U.S. data," Rabobank fixed income strategist Lyn Graham-Taylor said.
"The Fed is biased towards tapering... I think all of the indicators are seen as quite key, part of that building of the picture that the Fed wants, which is economic recovery so that it can taper a.s.a.p (as soon as possible)."