By Emelia Sithole-Matarise
LONDON, Sept 11 (Reuters) - Italian yields held steady on Friday before a sale of up to 7.75 billion euro of debt as concerns about an upcoming regional election in neighbouring Spain drove investors into the benchmark peripheral euro zone issuer.
Italian bonds have outperformed Spanish peers ahead of the Sept. 27 election in Spain's wealthy northern Catalonia region that secessionists want to use as a proxy for an independence referendum.
Spain's 10-year yield premium over Italian bonds rose on Tuesday to its highest in two years over 20 basis points as latest polls showed the pro-independence parties could win a majority of seats but fall short of 50 percent of the votes.
Italian 10-year yields were little changed at 1.84 percent while Spanish equivalents were 2 bps higher at 2.11 percent, keeping their yield gap near its widest in two years.
"While relative valuations versus Spain are expensive in our view, we expect the Italian auctions to go smoothly," said Commerzbank strategist David Schnautz.
"Some investors keen on large peripheral exposure but uncomfortable with Spain these days should ensure a warm welcome for the BTP supply."
Investors were also looking to a potential upgrade by Moody's of Ireland's credit ratings after the market close. Irish 10-year yields were 1 basis point lower at 1.31 percent.
"It is definitely conceivable that at least the outlook will be upgraded to 'positive'. The current Baa1 rating makes Moody's the last of the three major rating agencies to not yet have assigned a rating in the "A" category to Ireland," DZ Bank strategists said in a note.
"The return of Irish bonds to the core segment ought to continue and even accelerate in the form of noticeable spread narrowing in the coming weeks."
German 10-year yields, the euro zone benchmark, were also 1 basis point lower at 0.68 percent on growing doubts over the likelihood of a U.S. Federal Reserve interest rate hike next week.
Expectations that the U.S. central bank will act have fallen since the Fed gave no strong indication in the minutes of its July meeting that a September rate increase was likely. Low inflation is also seen as complicating the Fed's ability to raise interest rates.
(Reporting by Emelia Sithole-Matarise; Editing by Toby Chopra)