The two parties trying to form a new Italian government appeared close to a coalition deal on Tuesday, cheering financial markets as well as U.S. President Donald Trump, who said he hoped Giuseppe Conte would be reinstated as prime minister.

The role of Conte has been a sticking point in the negotiations between the 5-Star Movement, a member of the outgoing coalition, and the opposition Democratic Party (PD), which has been resisting his reappointment.

"Starting to look good for the highly respected Prime Minister of the Italian Republic, Giuseppi (sic) Conte," Trump said on Twitter. "A very talented man who will hopefully remain Prime Minister."

After setbacks early on Tuesday the roller-coaster talks between the anti-establishment 5-Star and the centre-left PD appeared to be back on track later in the day, with upbeat comments from both sides prompting a strong market rally.

Italian 10-year bond yields fell to three-year lows and the spread between German Bunds narrowed to below 182 basis points, the tightest since May 2018.

Investors betting Italy can avoid a snap election are concerned that it would be won by Matteo Salvini's hard-right League party, which would put the country on a collision course with the European Union over expansionary government spending.

"Our work is continuing in a fruitful way," the PD's Senate leader Andrea Marcucci told reporters in brief comments after an evening meeting with 5-Star officials.

Deputy PD leader Paola De Micheli said the two sides had "analysed points for the basis of a common programme", while 5-Star's Senate chief Stefano Patuanelli reported a "good climate" and said contacts would continue on Wednesday.

The parties are due to report back to President Sergio Mattarella on Wednesday from 1400 GMT. If no deal has been sealed he will name a caretaker government and call elections.

Conte, who belongs to no party but is close to 5-Star, resigned last week after League chief Salvini declared his 14-month coalition with 5-Star was dead, seeking to trigger elections and capitalise on his surging popularity.

The move has not gone to plan, as 5-Star and the PD seek to form a coalition of their own, pushing the League into opposition.

FIGHT OVER JOBS

Earlier on Tuesday the PD/5-Star talks seemed to have run into trouble, with the two sides fighting over key jobs as well as being at loggerheads over Conte's role.

The PD accused 5-Star of undermining the formation of a new cabinet by demanding the interior ministry for its leader, Luigi Di Maio. 5-Star denied this, and the parties cancelled a scheduled meeting.

Despite the later upbeat comments, tensions persist and surprises are possible .

The PD says Di Maio is insisting on keeping the role of deputy prime minister that he held in the outgoing government, something it considers unacceptable if Conte is to stay on as premier.

It remains to be seen if the exchanges are merely tactics to secure the upper hand in negotiations over cabinet jobs, or whether they have the potential to scupper an accord between the two parties which have always been bitter adversaries.

The picture is complicated by deep internal divisions in both parties, each one split between leadership factions that want a deal and others that would prefer to risk an election.

Di Maio was absent at the start of an evening meeting of all the 5-Star lawmakers. The great majority favours an accord with the PD rather than a snap election which would probably see many lose their seats less than 18 months into this parliament.

Meanwhile Salvini continues to demand elections, and is likely to be disappointed by Trump's endorsement of Conte, especially as the populist League chief has always expressed his admiration for the U.S. president.

Opinion polls suggest the League has lost 3-7 percentage points since collapsing the government, though it remains easily the most popular party, followed by the PD and 5-Star.