GLOBAL MARKETS-European shares ease on Italian debt sale, euro zone data

* Soft demand sees Italian yields rise at debt sale

* European shares dip as economic data disappoints

* Strong U.S. retail sales seen boosting Wall St

* Euro gives up gains to dip against dollar

By Richard Hubbard

LONDON, March 13 (Reuters) - European shares extended losses and Italian bond yields jumped on Wednesday after Italy's borrowing costs rose at a debt sale and data showed that euro zone factory output fell sharply in January.

However, U.S. shares were poised to gain after strong retail sales data for February showed American consumer spending holding up despite tax rises.

Italy sold 5.32 billion euros of new three- and 15-year government bonds at the auction, paying the highest yield since last December for the shorter term debt.

Subdued demand at the country's first debt sale since a downgrade by ratings agency Fitch sent the benchmark 10-year Italian bond yield up 10 basis points to 4.7 percent.

"Overall this is a weak auction result," said Lyn Graham-Taylor, a fixed-income strategist with London-based Rabobank.

"It may be that investors have been spooked by the ongoing political uncertainty in Italy."

Analysts said the impact on the whole market for peripheral euro zone debt would have been worse if it were not for the promise by the European Central Bank to buy unlimited amounts of bonds from countries that struggle to fund themselves.

"Without the ECB's pledge to backstop euro zone peripheral debt markets, post-election instability in Italy would have sent yields surging by now," said Nicholas Spiro, managing director at Spiro Sovereign Strategy.

"However, the strains are showing on Italy's government bond market."

Italy has been without a government since inconclusive elections late last month, which has raised fears over its ability to pursue much-needed reforms and underlined a Bundesbank warning that the euro zone crisis was far from over.

Concerns about the economic health of the region have been on the rise as more and more data suggests activity is continuing to weaken despite the ECB's efforts to keep monetary policy loose.

Industrial production data for January in the 17 countries that use the single currency added to the gloomy picture on Wednesday showing a surprisingly sharp 0.4 percent fall from December. Economists polled by Reuters had expected a 0.1 percent drop.

The growing worries over the region's outlook were also reflected in a German auction of new two-year bonds, which sold at an average yield of just 0.06 percent, compared with 0.21 percent on Feb. 13, demonstrating demand for safe-haven assets.

SHARES SLIDE

The weak data and rising Italian bond yields sent the pan-European FTSEurofirst 300 share index down 0.4 percent, extending its slide for the week to 0.5 percent, which would be its worst weekly performance for over a month.

Italy's main share index, the FTSE MIB, was down 1.85 percent, its biggest daily fall since the election result. London's FTSE 100, Paris's CAC-40 and Frankfurt's DAX were between flat and 0.9 percent lower.

A subdued showing on Wall Street on Tuesday - where the Dow Jones Industrial Average managed only the slightest of gains - and a sell-off in Tokyo had already made equity markets more cautious about pursuing a rally that started after Friday's strong U.S. jobs report.

As a result MSCI's world equity index was down 0.25 percent at 359.83 points, on course for its worst day of the month.

In the currency market the debt auctions and weak data saw the euro give up its early gains against the dollar to stand down 0.15 percent at $1.3010, though still well within the $1.2955-$1.3135 range it has moved in this month.

Against a resurgent yen, the euro fell 0.5 percent to $1.2454. The Japanese currency has been under pressure on prospects for much bolder monetary easing from the Bank of Japan, but some investors were taking profits after the fall.

In the commodity market oil rose slightly as expectations of steady global consumption growth and a surprise fall in U.S. stockpiles helped keep Brent crude above $109 a barrel.

"Downside risks for oil seem to be very limited," said Tetsu Emori, a commodities fund manager at Astmax Investments. "I think oil prices have bottomed out, and overall we will see a recovery."

But a report from the International Energy Agency (IEA) that production in the United States would be enough to protect against most potential supply shocks capped prices.

Brent crude was flat at $109.70 a barrel, while U.S. oil rose 27 cents to $92.81, gaining for a fifth day in the longest daily winning streak since mid-December.

However, gold prices drew some strength from the rising concerns about the euro zone after the disappointing factory output data, having already hit its highest level since Feb. 28 at $1,598.20 on Tuesday.

Spot gold was up 0.3 percent to $1,595.84 an ounce and U.S. gold futures for April delivery rose 0.2 percent to $1,594.90.