* Possibility of Italian elections unnerves financial markets
* Euro weighed by sharp decline in German bund yields
* Dollar index around its highest since mid-November
* Euro falls to 11-month low vs yen (Adds details and quotes, updates prices)
By Shinichi Saoshiro
TOKYO, May 29 (Reuters) - The euro struggled near a 6-1/2-month low against the dollar on Tuesday, as the bounce seen at the start of the week faded and investors took a grim view on the prospect of fresh elections in Italy.
The common currency was little changed at $1.1629 after slipping overnight to $1.1607, its lowest since Nov. 9.
It had spiked to $1.1728 earlier on Monday after Italian President Sergio Mattarella rejected a vocal critic of the single currency as economy minister.
But Mattarella’s veto angered the anti-establishment parties which had been trying to forge an alliance, prompting them to abandon their coalition plans and setting the stage for fresh elections.
Financial markets fear that the elections, which could take place as early as August, are seen as a quasi-referendum over Italy’s role in the European Union and euro zone and could end up strengthening eurosceptic parties even further.
Such worries have resulted in a big sell-off of Italian debt and a surge in safe-haven German bond prices. As a result, the yield spread between 10-year German and Italian bonds was at its broadest since December 2013.
“The sudden, broad widening of euro zone yield spreads caught market participants off guard and is a key factor in the euro’s sell-off. Basically, German bund yields are declining and this is negative for the euro,” said Yukio Ishizaki, senior currency strategist at Daiwa Securities in Tokyo.
“There are still a lot of euro long positions that had been built up during the currency’s bull phase until May that need to be unwound, and the euro’s decline looks set to continue indefinitely.”
The chill in broader investor risk appetite boosted the yen against its peers.
The euro was down 0.45 percent at 126.620 yen following a descent to an 11-month low of 126.520. So far in May it has lost 4 percent against the yen, which tends to attract demand during political unrest and market turbulence.
“The euro’s weakness is a key factor behind the yen’s strength. The yen’s strength relative to the euro is in turn lifting it against the dollar,” said Shusuke Yamada, chief Japan FX strategist at Bank of America Merrill Lynch.
With a decline in U.S. Treasury yields also weighing, the greenback lost about 0.4 percent to a three-week low of 108.910 yen.
The dollar rose briefly to 109.830 yen on Monday as U.S.-North Korea summit plans appeared to get back on track, but the relief has been quickly eclipsed by euro zone political concerns.
The dollar index against a basket of six major currencies was 0.2 percent higher at 94.370 and not far from a 6-1/2-month peak of 94.496 scaled on Monday.
The Australian dollar, sensitive to shifts in risk sentiment, was down 0.3 percent at $0.7525. The New Zealand dollar slipped 0.2 percent to $0.6929.
Reporting by Shinichi Saoshiro Editing by Eric Meijer and Sam Holmes