* Italian bond yields fall after hefty Tuesday sell-off * Focus also on Treasuries (Updates prices, adds background) AMSTERDAM, Jan 13 (Reuters) - Italy’s government bond yields fell sharply on Wednesday despite ongoing uncertainty over the future of the government in Rome. Other European government bond yields were also lower, but the drop was more moderate, with peripheral countries roughly in line with the core, tracking U.S. Treasuries. Italian Prime Minister Giuseppe Conte told reporters he was working on a new coalition pact to last until the end of the legislature and said he was convinced that unity could be restored if there was goodwill from all sides. Ten-year Italian government bond yields were down 8 basis points to 0.55% after a 10 bps rise on Tuesday delivered their worst session since early November. Five-year Italian yields returned to negative territory after rising above zero for the first time since mid-November on Tuesday. Although Tuesday’s moves reflected political uncertainty, this has not materially raised the likelihood of a snap election, bond analysts said. Investors likely took the opportunity to take profits on Italian government bonds, analysts said, after the risk premium recently fell to its lowest since 2016, below 100 bps. The closely-watched gap between 10-year Italian and German yields, effectively the risk premium on Italian debt, was at 106 bps after hitting 111 bps, its highest in nearly a week. “If Renzi leaves the government, it could trigger a reshuffle and a new government, but the impact on the Italian government bonds should not be long lasting,” Jens Peter Sorensen, chief strategist at Danske Bank in Copenhagen, said. “We expect the spread to stabilise as this is more on internal political noise in the Italian government rather than Italy’s commitment to Europe.” In higher-rated markets, benchmark German 10-year yields fell 5 basis points after rising on Tuesday in tandem with U.S. Treasuries. Government debt sales were also in focus, with Spain due to place 10 billion euros ($12 billion) of benchmark bonds maturing in April 2031 to final demand of 56 billion euros, a Treasury source told Reuters, well below last April’s record books and initial demand earlier in the day. Germany raised 4.066 billion euros from a new five-year bond auction, while Portugal raised 1.25 billion euros from the reopening of bonds due 2030 and 2035. The European Central Bank is keeping a close eye on exchange rate developments and their negative impact on inflation, ECB policymaker Francois Violleroy de Galhau said on Wednesday. President Christine Lagarde also warned not to target the bloc’s exchange rate. ($1 = 0.8201 euros) (Reporting by Yoruk Bahceli and Stefano Rebaudo; Editing by Alexander Smith)