UPDATE 2-Bank stocks, Italy bonds rally as ECB's Coeure paves way for new cash boost for banks

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LONDON, Feb 15 (Reuters) - Euro zone banking shares jumped over three percent, the euro fell and Italy’s bond yields tumbled on Friday after the European Central Bank’s Benoit Coeure said a new round of cheap multi-year loans to banks was possible.

Weak economic data, combined with uncertainty over Brexit and global trade tensions, have raised expectations that fresh stimulus measures from the ECB are likely in coming months.

That speculation got a fresh boost after ECB board member Coeure said the central bank was discussing the idea of issuing new multi-year cheap loans to banks, which in some countries face a funding cliff-edge next year when previous loans must be repaid.

Banks in Italy and other southern European countries in particular could face funding problems as the ECB’s most recent Targeted Long-Term Refinancing Operation (TLTRO) nears its repayment date in 2020.

The prospect of fresh ECB stimulus cheered banking stocks, which have been hurt by an era of negative interest rates, as well as southern European bond markets.

An index of euro zone bank shares was up 3.8 percent -- it was set for its biggest one-day gain in a month.

Relief also washed through Italian markets, which in particular have been hit by concerns about weakening growth.

“For Italian banks it is absolutely crucial there is a discussion about TLTROs,” said Daniel Lenz, rates strategist at DZ Bank, referring to Targeted Long Term Refinancing Operations -- the official name of the ECB’s last loan package to banks.

“The Southern European banks have refinanced themselves at minus 40 basis points and if they have to refinance at mid-swaps plus 200 basis, it would make a huge difference in funding. It is critical for them to have access to cheap liquidity.”

Italian banking stocks were last up 4 percent, outperforming the broader Italian stock market. The euro also fell and was last down 0.3 percent at $1.1265.

Italian two-year bond yields were down 2.5 basis points at 0.46 percent, while Italy’s 10-year bond yield was flat at 2.81 percent having given up earlier sharp rises.

In a volatile session, Italian yields had earlier jumped to stand as much as 9 bps higher on the day, after League party lawmaker Claudio Borghi said the country could leave the European Union if there were no changes in the bloc after parliament elections in May.

The comments revived concerns about Italy’s commitment to the euro, a fear that rattled markets last year.

“So when he (Borghi) repeats these comments, investors price in more risk for Italian debt and that impacts corporates and ultimately Italian financial conditions,” said Peter Chatwell, head of rates at Mizuho.

Spanish government bond yields meanwhile pulled back from the day’s highs hit after Socialist Prime Minister Pedro Sanchez called a snap election for April 28.

Ten-year Spanish bond yields were last up around a basis point at 1.24 percent, having touched 1.27 percent.

Reporting by Dhara Ranasinghe and Helen Reid; Editing by Sujata Rao, William Maclean