Italy yields dip as Rome seeks property tax deal
* Rome seeks to ease political crisis by scrapping property tax
* Some investors take profits on Spain vs Italy trades
* Bunds reverse gains on BoE chief's comments
* Sharp bund sell-off unlikely as Syria turmoil eyed
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, Aug 28 (Reuters) - Italian bond yields dipped on Wednesday as Rome was seen close to scrapping a controversial property tax in an effort to calm tensions within the country's ruling coalition.
Italian debt outperformed other euro zone bonds, including low-risk German Bunds which fell in line with UK gilts after Bank of England Governor Mark Carney did little to alter market expectations that rates could rise much earlier than he flagged.
The Italian cabinet was due to pass a decree later in the day to settle the issue which had threatened to split the coalition and deepen political turmoil caused by former premier Silvio Berlusconi's conviction for tax fraud.
While this could ease tensions near-term, questions remained about how the government would plug an ensuing funding shortfall of over 4 billion euros while a looming vote on whether to expel Berlusconi from parliament kept investors edgy about the stability of the coalition.
Italian 10-year yields fell 5 basis points to 4.40 percent, reversing some of this week's rise, helping Italy's debt premium over low-risk German Bunds to fall 9 bps on the day to 252 bps.
"BTPs have done quite well, even though we've got auctions tomorrow, on reports the Italian government is close to agreeing to scrap this homes levy tax as demanded by Berlusconi's party," a trader said.
"That has taken the immediate political risk off the situation but I'm not sure whether in the long run this is very good news for BTPs as this entails a funding shortfall and they are going to have to find that from somewhere."
Italian bonds regained some ground over Spanish peers, as some investors who have bet Italian debt will lag Spanish bonds took profits on the trade after the yield spread between them came close to reversing on Tuesday, traders said.
The Spanish/Italian 10-year yield gap was last at 12 bps, after hitting its tightest in 1-1/2 years at 2 bps on Tuesday.
"We see a bit of a reversal of what we had yesterday, but despite today's strength I still expect Italy will continue to underperform Spain because of the Berlusconi situation," ING rate strategist Alessandro Giansanti said.
He estimated Italian yields could trade 5 bps higher than the Spanish ones near-term if political uncertainty lingers.
Positioning for upcoming debt auctions has also weighed on Italian bonds recently. Italy plans to sell up to 6 billion euros of five- and 10-year bonds on Thursday which analysts said would show how the country's political risks and the increasing prospect of a military strike on Syria by Western powers was affecting foreign investors' demand for its debt.
Bund futures settled down 24 ticks on the day at 140.30, giving up almost half the previous day's gains after Carney's speech on Wednesday fell short of expectations of some investors who had anticipated a more dovish tone to dampen growing bets on an earlier monetary tightening.
Some traders said markets had also largely adjusted to a potential Western strike on Syria and only a broader escalation of the conflict would fuel significantly more flows into Bunds.
German 10-year yields were up 2.4 bps at 1.88 percent, still some 10 bps away from Friday's 1-1/2 year highs of 1.98 percent.
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