* Political crisis in Italy fuels bond market selloff
* Euro on track for biggest monthly drop in more than 3 yrs
* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
By Saikat Chatterjee
LONDON, May 29 (Reuters) - The euro hit a 6-1/2 month low on Tuesday, falling for a third day in row as a selloff in Italy’s bond markets due to rising political worries there drove investors to dump the single currency.
Italy’s president set the country on a path to early elections on Monday, appointing a former International Monetary Fund official as interim prime minister with the task of planning for snap polls and passing the next budget.
Financial markets are concerned the elections, which could take place as soon as August, might serve as a quasi-referendum on Italy’s role in the European Union and euro zone and strengthen the country’s eurosceptic parties even further.
The euro dropped below $1.16 for the first time in 6-1/2 months on Tuesday, down 0.3 percent on the day. Against the Swiss franc, it fell by a similar margin to 1.1528 francs .
“The spillover effect on the euro from the Italian bond markets is limited for now but that can change if the selloff forces investors to dump other peripheral debt,” said Viraj Patel, a currency strategist at ING in London.
On a monthly basis, the euro has fallen more than 4 percent and is set for its biggest monthly drop in more than three years, according to Thomson Reuters data.
Italy’s two-year bond yield was up 54 bps at 1.42 percent having earlier touched 1.70 percent — its highest since late 2013.
“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,” said Yukio Ishizaki, senior currency strategist at Daiwa Securities in Tokyo.
With a decline in U.S. Treasury yields also weighing, the greenback lost about 0.6 percent to a three-week low of 108.730 yen.
The dollar rose briefly to 109.830 yen on Monday as U.S.-North Korea summit plans appeared 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 up half a percent on the day at 94.70, hitting a 6-1/2 month high.
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 Saikat Chatterjee; Additional reporting by Shinichi Saoshiro in TOKYO; editing by John Stonestreet)