ROME/LONDON (Reuters) - Italy is making preparations to issue its first dollar-denominated bond in eight years and is talking to investment banks about setting up swap infrastructure for the deal, several sources told Reuters.

Rome is keen to diversify its funding sources away from the euro zone bond market, especially as its sovereign borrowing needs are likely to rise to meet the election promises of the ruling coalition. Italy’s public debt is large and second only to that of Greece as the highest in the euro zone relative to its economic output.

An Italian economy ministry official said the government was working with banks to update rules on how it would post collateral on derivative trades linked to the new issue.

In the wake of the financial crisis, lenders are under regulatory scrutiny to better manage the risk on their books and the amendments aim to make it easier for banks to manage a dollar issue and for Italy to sell bonds in foreign currencies.

“The Treasury is defining the contract scheme, all the specialists are involved,” the official said, speaking on condition of anonymity.

The official said the Treasury aimed for the steady issuance of dollar bonds under a new bond programme. But Italy will only return to issuing dollar bonds if its cost of funding is cheaper than for euro-denominated BTPs.

Italy had 2.26 trillion euros (2 trillion pounds) in government debt outstanding at the end of 2017, according to Eurostat.

This includes two dollar issues maturing in 2023 and 2033 IT004622596=IT016409294= and worth $3.5 billion and $2 billion respectively.

A three-year dollar bond issued in September 2010 has already matured.

The new dollar issues are likely to be governed by New York law, which some investors feel offers stronger protection against debt restructuring, including a currency redenomination, than euro issues under Italian law.

Both the existing dollar bonds outperformed their Italian-issued, euro-denominated peers during May’s bond rout..

Two primary dealers in London told Reuters the process had been in the works for a while. The government said in February it planned to issue dollar bonds by mid-2019.

“It has been on the agenda for much of this year in Italy, and it is a bit of a priority for the Treasury to regain access to the dollar markets,” said one of the bankers.

But the second banker was unsure the deal would get off the ground just yet because of Italy’s political situation. The country will present a 2019 budget plan in October that investors fear could breach EU spending limits.

“I would strongly recommend them or any other issuer to diversify if they can, but certainly not Italy at the moment -- I would wait until this current situation stabilises and the dust settles,” the banker said.

“I wouldn’t rule out this year but next year is more realistic.”