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* South European yields drop as political worries ease
* Carney reinforces benign monetary policy backdrop
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Abhinav Ramnarayan
LONDON, June 20 (Reuters) - The gap between Italian and German 10-year borrowing costs hit its narrowest level in five months as euro zone bond investors start to price in what they see as a dramatic reduction in the risk that the bloc will break up.
Earlier this year, government bond prices in southern Europe were under pressure from uncertainty over how French elections in May would play out, the possibility of a snap vote in Italy and speculation over European Central Bank tapering of its extraordinary monetary stimulus.
But recent indications suggest the ECB is in no hurry to end its programme, the election of President Emmanuel Macron has helped soothe concerns and worries on Italy have also faded.
"The perception in the market is that the main political risks that were the dominating factors (in euro zone bond markets) are now behind us," said DZ Bank strategist Christian Lenk. "Investors are now happy to take some carry into the summer months."
The Italian-German bond yield spread, which is closely watched as a key indicator of political risk in the bloc, dropped to 165 basis points, its narrowest level since early January.
Low-rated Southern European government bonds were in demand in general on Tuesday, dropping 1-2 bps on the day.
Italian and Portuguese bonds in particular had rallied after Macron scored a strong victory in French parliamentary elections.
Low-rated South European government bonds tend to rally when risk appetite is high and when the threat of euro zone break up is at an ebb.
The promise of continued monetary stimulus is also positive for lower-rated bonds in the bloc, and indications are that central bankers in major developed countries are all hesitating to tighten monetary policy.
On Tuesday, Bank of England Governor Mark Carney said now is not the time to raise rates.
For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets
Reporting by Abhinav Ramnarayan; Editing by Raissa Kasolowsky