* Risk aversion grips world markets amid EM turmoil
* German, U.S. bond yields at 3-week lows
* Italy’s bond yields higher (Updates price action, adds ECB statement on Greece)
By Dhara Ranasinghe
LONDON, Aug 10 (Reuters) - Most euro zone bond yields fell on Friday, with German borrowing costs at three-week lows as turmoil in major emerging markets Turkey and Russia boosted demand for safe-haven government debt.
The exception was Italy. Its bond yields, already pushed up by concerns about upcoming budget talks, faced additional upward pressure as risk aversion gripped world markets.
Turkey’s lira hit the latest in a string of record lows on Friday on the back of a deepening rift with the United States, worries about its own economy and lack of action from policymakers.
Markets were also unnerved by a report in the Financial Times that the European Central Bank was worried about European banks’ exposure to the country.
The ECB, which declined to comment on the report, is said to be chiefly concerned about Spain’s BBVA, Italy’s UniCredit and France’s BNP Paribas.
Shares in these banks fell more than 3 percent each, while the euro tumbled to its lowest levels in more than a year .
Most 10-year euro zone bond yields fell three to five basis points on the day, with French and Dutch 10-year yields falling to their lowest point in nearly three weeks.
Yields on 10-year German bonds, regarded as one of the safest assets in the world, also hit three-week lows of 0.328 percent and were set for the biggest one-week fall in seven weeks. Germany’s five- and 30-year bond yields were four and five bps lower, respectively.
U.S. and British 10-year bond yields fell to their lowest levels in almost three weeks .
“There is a clear safe-haven bid for bonds given concerns about the so-called bank-sovereign doom loop,” said DZ Bank strategist Andy Cossor.
Berenberg European economist Carsten Hesse said in a note that while a full blow Turkish banking crisis would have some negative repercussions for euro zone banks with a large exposure to Turkey, the overall exposure of the euro zone banking sector seems too small to spark a “significant” euro zone crisis.
European stock markets fell 1.09 percent. In addition to Turkey’s woes, a slide in the Russian rouble this week on threats of new U.S. sanctions and nagging worries about a global trade war have jolted world markets.
Italian bonds and equities felt the ripple effects as investors steered clear of risky assets, while domestic political worries also weighed on sentiment.
Italy should scrap a clause in its constitution obliging it to run a balanced budget, deputy Prime Minister Luigi Di Maio said, adding that the government was not yet working on the matter.
Markets fear the big spending plans of the new anti-establishment coalition will push up Italy’s already high debt levels and put it on a collision course with the EU and its fiscal rules.
Italy’s stock market took a hammering, with the FTSE MIB falling 2.4 percent to a more than one-year low.
Its bonds also sold off with yields rising between six and 13 bps towards the end of the day’s trading. Italy’s 10-year bond yields rose six bps to 2.96 percent, pushing the gap over German peers to 263 bps from 253 bps late on Thursday.
Italian debt insurance costs hit the highest level in two months.
While the general risk-off tone also hit Greek bonds, leading to some early selling, Greece’s bond yields held firm after the European Central Bank shored up plans to end its banks’ access to cheap funding, a move that could increase costs for lenders but may still help shore up confidence in Europe’s weakest economy.
Greek two-year bond yields were up seven bps, with the rest of the curve largely unchanged.
Reporting by Dhara Ranasinghe, Additional reporting by Karin Strohecker; Editing by Janet Lawrence and Hugh Lawson