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* Italy's Letta names government, ends political stalemate
* Italian, Spanish government bonds rally
* Bunds rise as German data reinforces ECB rate cut bet
By Ana Nicolaci da Costa and Marius Zaharia
LONDON, April 29 (Reuters) - Italian bond yields fell on Monday and were expected to ease further after new Prime Minister Enrico Letta named a coalition government, helping the country to sell debt at the lowest cost since October 2010.
German Bunds also rose after data reinforced bets that the European Central Bank will cut interest rates on Thursday - an expectation that has in recent weeks lifted both safe-haven Bunds and riskier peripheral debt.
"We are at the point where both Italian bond yields and German yields are falling, so something has got to give at some point," Nick Stamenkovic, strategist at RIA Capital Markets said.
Throughout much of the three-year crisis German bonds have tended to trade in the opposing direction to debt from more vulnerable euro economies. Investors favour Germany in times of turmoil and debtors such as Spain and Italy when they are willing to take risk.
"Given the weak economic picture we have seen both in Europe, and in the U.S. ... the likelihood is that the recent rally in peripherals will start to run out of steam sooner rather than later," Stamenkovic added.
But on Monday 10-year Italian government bond yields fell 15 basis points to 3.92 percent as the euro zone's third largest economy got a government after a two-month impasse that has held up reform efforts.
The treasury sold all of its planned 3 billion euros ($3.9 billion) of 10-year bonds at 3.94 percent at auction, well below the 4.66 percent it paid a month ago. It also sold 3 billion euros of five-year bonds at 2.84 percent, 0.82 percentage points less than in March.
Letta, of the centre-left, was expected to win parliament's backing in a confidence vote later in the day. He relies on the support of his centre-right rivals, led by former premier Silvio Berlusconi.
"On the very short term the new government is supportive. The composition is quite mixed, with good representation of the main parties and some technocrats in the key ministries," said Annalisa Piazza, market economist at Newedge Strategy in London.
"There is a chance that markets will price in a long-lasting government ... of at least one year, which will be enough time to push through some reforms."
She said the Italian/German 10-year yield spread could narrow to 180-190 basis points over a three- to six-month period from around 270 bps currently.
Rabobank's senior rate strategist Richard McGuire also said the gap could tighten to about 200 bps.
Spanish 10-year yields fell 12 bps to 4.16 percent as Italy pulled other higher-yielding markets with it.
Some investors were reluctant to take new positions in Italy at the current level of 10-year yields, which is just off a 2-1/2 year low of 3.89 percent hit last week.
"We're moving towards a more stable electoral background," said Sanjay Joshi, head of fixed income for London and Capital, a group managing assets worth around $4 billion which sold its Italian and Spanish debt holdings before the elections.
"But we haven't made any moves yet. Economic conditions in other euro zone countries have deteriorated."
Data this session reinforced bets that the ECB will cut interest on Thursday.
German annual inflation eased to its lowest level in more than two years in April and confidence in the euro zone's economy fell further in April, separate data releases showed on Monday.
Subdued inflation in Germany and the United States prompted German Bund futures to reverse losses and they eventually settled up 12 ticks on the day at 146.66.