* Euro zone bonds rally as ECB to increase PEPP purchase pace * Italian yields, risk premium fall to 3-week lows * Bank shares tumble (Adds details, comments) March 11 (Reuters) - Euro zone government bond yields and bank shares fell after the European Central Bank said it would conduct emergency bond purchases at a significantly higher pace over the next quarter to combat a recent rise in bond yields. The decision assuaged some doubts around the bank’s resolve to calm market nerves and support indebted governments through the pandemic after it barely increased the pace of its pandemic emergency bond purchases (PEPP) in recent weeks, despite a sharp rise in global bond yields. Following the ECB’s announcement, Germany’s 10-year government bond yield, the region’s benchmark, fell to its lowest since Feb. 18 at -0.37% and was last down 3 basis points at -0.34% at 1515 GMT. Benchmark 10-year yields in Italy -- among the biggest beneficiaries of ECB bond buying -- fell as much as 10 basis points to 0.57%. and were last down 8 basis points at 0.60%. That closely watched gap between German and Italian 10-year bond yields -- effectively the risk premium on Italy’s debt -- tightened to around 92 basis points, its tightest since Feb. 23. Mauro Valle, head of fixed income at Generali Investment Partners, said the announcement confirmed the ECB’s intention to avoid higher rates and tighter financing conditions. The ECB did not specify by how much the pace of PEPP purchases would increase. It noted that its governing council does not monitor PEPP purchases on a weekly basis and is not undertaking yield curve control: a strategy where a central bank targets a specific rate on longer-term bonds and buys what is necessary to enforce it. Antoine Bouvet, senior rates strategist at ING, said he saw room for PEPP purchases to increase to as high as 110 billion euros a month, similar to the pace in Q2 2020, when the ECB was fighting a sharp rise in the pandemic-induced rise in government bond yields. That could lower the 10-year Bund yield around 10 basis points compared to his earlier expectations for this quarter, he said. “Beyond that, I think the market impact will quickly fade if the envelope is not increased,” Bouvet added, referring to the total headroom available under the PEPP programme. Euro zone banks accelerated their losses sharply following the statement, trading down over 2%. “It’s a bit of a Pavlovian response, the ECB said it will catch back on the rhythm of purchases and anything that one way or another pushes yields down, pushes banks down too”, said Jerome Legras, head of research at Axiom Alternative Investment. “That said (euro zone) banks have really well performed since the beginning of the year so this gives them an opportunity to take a breather.” The euro lost some of its gains from earlier in the session, dipping as low as $1.1939 after the policy decision announcement.. (Reporting by Stefano Rebaudo, Yoruk Bahceli; additional reporting by Julien Ponthus, Elizabeth Howcroft and Joice Alves; Editing by Bernadette Baum, Alison Williams and Jonathan Oatis)