* Euro zone yields up 2-6 bps as trade war fears ebbs
* Italy/German gap hits 2-month low in early trade
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)
By Fanny Potkin
LONDON, April 5 (Reuters) - Borrowing costs across the euro zone rose on Thursday as stock markets recovered from a selloff triggered by worsening Sino-U.S. trade tensions, curbing the demand for safe-haven debt.
Italian debt was a focus for investors for a second day as the premium demanded to hold it over the bloc’s benchmark Germany dropped to a two-month low as talks on forming a coalition cranked up in Rome.
Market sentiment was lifted as Washington expressed willingness to negotiate after proposed U.S. tariffs on $50 billion of Chinese goods prompted swift retaliation from Beijing . Investors took heart that a trade war between the world’s two biggest economies could be avoided after President Donald Trump’s economic adviser, Larry Kudlow, said the administration was in “negotiation” with China, and not engaged in a trade war.
The news helped drive European stocks sharply higher on Thursday, led by the STOXX 600 .STOXX rising 2.16 percent to a two-week high and following a relief rally on Wall Street and Asian markets.
Most government bond yields across the bloc were up 2 to 6 basis pointsas the session drew to a close.
Germany’s benchmark 10-year bund yield was trading at 0.525 percent, up 3 basis points on the day
Bund markets also found no comfort in data that showed German industrial orders rose less than expected in February due to weak domestic demand.
Italian debt continued to outperform its peers, though it gave back some earlier gains after the centre-left Democratic Party declared on Thursday it planned to remain part of the opposition in the new parliament and not join any coalition government.
Italy’s 10-year bond yield rose from a four-month low of 1.732 percent to 1.77 percent.
Italian President Sergio Mattarella was holding a second day of talks to try stitch together a new government after an inconclusive March 4 election.
Italian bonds have been trading at a clear premium to their Spanish equivalent; that gap tightened on Thursday to 56.2 basis points, its narrowest in 2 months, while the gap over Bunds narrowed to 122 basis points.
Elsewhere, France auctioned 7.665 billion euros of its long-dated bonds, below the 7.5 billion- to 8.5 billion-euro range it targeted.
Spain sold 4.019 billion euros in long-dated bonds, out of a targeted 5 billion euros. (Reporting by Fanny Potkin editing by Mark Heinrich)