* Italian bond yields dip after Thursday sell-off
* But set for biggest weekly rise since October
* Focus on Monday’s vote of confidence (Changes headline, updates prices)
AMSTERDAM, Jan 15 (Reuters) - Italian bonds showed some recovery on Friday as yields dipped, but borrowing costs were set for their biggest weekly rise in 12 weeks as the market focused on political uncertainty in Rome.
Italian Prime Minister Giuseppe Conte resisted calls to resign on Thursday after a junior coalition party led by former premier Matteo Renzi withdrew from the government on Wednesday and stripped it of its majority.
Instead, Conte signalled he wanted to take his fight for survival to parliament, with his main coalition partners backing plans to seek support among opposition ranks to prop up the administration.
He will address Italy’s Chamber of Deputies on Monday and then a vote of confidence is expected to indicate whether he can battle on.
A tougher test awaits Conte the following day in the Senate, where he is struggling to find a majority to back him.
On Friday, Italy’s bond market was poised to end the week calmer, as 10-year bond yields were down 3 basis points at 0.575% in late afternoon trading.
“We see new elections as the worst possible outcome for BTPs, but this is highly unlikely, in our view,” Societe Generale analysts Jorge Garayo, Ninon Bachet and Adam Kurpiel told clients, echoing a view held by many bond analysts.
“There is still a chance that PM Conte will manage to secure support after deliberations with Renzi and other parliamentarians. This would be the best outcome for BTPs,” they said, referring to Italian government bonds.
Several sessions of hefty sell-offs this week put 10-year yields on track to end the week 8 basis points higher, their biggest weekly rise since the week ending Oct. 23.
BTPs outperformed German bonds on Friday, pushing down the closely watched gap between German and Italian 10-year bond yields to 111.5 basis points, from seven-week highs around 118 bps hit on Thursday.
But the spread, effectively the risk premium Italy pays on its debt, is up over 10 bps this week, after falling to its lowest since 2016 below 100 bps last week.
Analysts at Mizuho expect it to widen to 130-150 basis points until the issue is resolved, although support from the European Central Bank’s asset purchases are expected to limit the sell-off.
The Italian government has approved a new stimulus package worth 32 billion euros to prop up its coronavirus-battered economy, which will push this year’s budget deficit to 8.8% of GDP from the current goal of 7%.
Elsewhere, German 10-year yields, the euro area’s benchmark, were up 1 basis point to -0.545% after two consecutive days of sizeable falls.
Reporting by Yoruk Bahceli; Additional reporting by Julien Ponthus in London; Editing by Susan Fenton, Alison Williams and Barbara Lewis
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