* Rome aiming to approve bad loan guarantee next month
* Prime minister Renzi says close to support deal with EU
* Italy-Germany bond yield spread lowest in three weeks
* Spain, Portugal await euro zone sanctions decision
By John Geddie
LONDON, July 12 (Reuters) - Italian government borrowing costs edged lower on Tuesday, narrowing the gap with benchmark Germany, as Rome moved closer to a deal to safeguard the country's struggling banks.
Rome is aiming to approve a decree offering banks a state guarantee to help them sell their bad loans by the beginning of August, a source close to the matter said on Monday, with the first portfolio ready for sale.
Italy's lenders have been struggling for months to unload 360 billion euros ($400 billion) of non-performing loans - about one third of the euro zone total.
But Prime Minister Matteo Renzi said a deal with the European Commission to allow public support for its weakest lenders was "absolutely within reach". European Union rules allow state aid to banks only in exceptional circumstances.
"If there is some way in which Italy's banks can offload their inventory of bad loans then that would be seen as very positive for the economy and, in turn, allow government spreads to tighten further," Mizuho strategist Peter Chatwell said.
Italian 10-year yields fell 2 basis points to 1.12 percent , according to Tradeweb data, having initially been marked higher in early trades on Tuesday.
The gap between Italian and German 10-year yields was at its lowest in almost three weeks, pulling back from a 4-1/2-month high hit in late June.
Shares in Italian banks rose nearly 4 percent on Tuesday , led by a near-7 percent rise in UniCredit's stock after it offloaded a stake in its online banking unit.
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WIGGLE ROOM
Asked about Rome's plans to back its banking sector with state aid, Eurogroup head Jeroen Dijsselbloem said on Monday that he saw no "acute crisis" in Italy's banks and that bailing out lenders will have an impact on private investors.
The EU's bank rescue rules in force since January make the use of public money to bail out banks also conditional on losses for banks' creditors - although some wiggle room is allowed.
Rome is trying to avoid hitting small savers, which caused mass protests and the suicide of a saver when the Italian government rescued four small lenders in November wiping out private investors' savings.