* Portugal bond yields rise as Novo Banco sale faces hurdles
* Most euro zone yields down on flight-to-safety, dovish remarks
* France/Germany bond yield spread drops before TV debate
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices for close)
By Abhinav Ramnarayan
LONDON, April 4 (Reuters) - Italy outperformed other euro zone government bond markets on Tuesday after the European Commission said there could be a solution on a bailout for two struggling Italian lenders.
A spokesperson said on Monday that the Commission was in “constructive talks” with Italian authorities and the European Central Bank on a request for state support by Banca Popolare di Vicenza and Veneto Banca.
“Italy’s banking sector has been a never-ending story, so any news pointing towards state support reduces the risk of a more severe development that could be the beginning of a banking crisis,” said DZ Bank strategist Daniel Lenz.
“Anything that prevents that is good news even if it costs the state extra money, especially when liquidity is so cheap at the moment,” he added, referring to the fact that Italian borrowing costs are low by historic standards thanks to the European Central Bank’s bond-buying scheme.
Two other analysts said Monday’s rumours of a new long-dated syndicated bond sale by Italy may also be playing havoc with its bond curve, pushing yields higher on Monday and prompting a retracement on Tuesday when the deal did not materialise.
The struggling banking sector is seen as a key factor dragging down Italy's economic prospects and was one of the reasons cited by ratings agency DBRS when it downgraded Italy in January. bit.ly/2inrkdx
Italy’s 10-year government bond yield fell as much as 8 basis points to its lowest level since March 16 at 2.244 percent. It closed at 2.27 percent.
Banca Popolare di Vicenza’s senior debt rallied on Tuesday as investors bet the troubled Italian regional bank will be granted the state aid.
Portugal’s efforts to solve its banking issues did not seem to be going as smoothly. BlackRock and other asset management institutions are seeking an injunction this week to block the sale of Portugal’s Novo Banco to U.S. private equity firm Lone Star.
Novo Banco is a state-backed entity created in 2014 as part of a rescue of failed Portuguese lender Banco Espirito Santo.
Portugal’s government bonds were notable underperformers on the day. Its 10-year bond yields rose 3 bps to 3.95 percent, as most euro zone government borrowing costs fell.
The yield on Germany’s 10-year government bond , the benchmark for the region, fell nearly 4 bps to a new one-month low of 0.237 percent and most other euro zone government bond yields were down 2 to 4 bps.
“This is driven by flight to safety and the dovish rhetoric we are seeing from policymakers in Europe and the U.S.,” said ING strategist Martin van Vliet.
German government bond yields tumbled on Monday after a subway explosion in Russia’s St. Petersburg.
An impending meeting between U.S. President Donald Trump and his Chinese counterpart, Xi Jinping, and tensions over the British overseas territory of Gibraltar may have also contributed to the bid for high-quality government paper.
French government bond yields fell nearly 6 basis points to 0.893 percent, outpacing German bond yields, with French presidential candidates due to debate on television on Tuesday ahead of elections that begin this month.
Polls showed the race is looking increasingly tight with three weeks to run before voting starts. (Editing by Susan Thomas and Susan Fenton)