By Antonella Cinelli

ROME (Reuters) -Italy narrowly avoided recession in the third quarter, data showed on Thursday, with gross domestic product stagnating following a marginal contraction in the second quarter, and underperforming most of its European peers.

On a year-on-year basis, the euro zone's third-largest economy grew by a weak 0.4% between July and September, national statistics bureau ISTAT said in its preliminary estimate

The 20-nation currency bloc grew by 0.2% quarter-on-quarter and by 1.3% year-on-year, Eurostat reported separately.

Italy avoided by a whisker a so-called technical recession, defined by economists as two consecutive quarters of falling GDP, after a 0.1% quarter-on-quarter contraction in the April to June period, confirmed by ISTAT.

The flat quarterly GDP reading between July and September was the result of shrinking domestic demand and a positive contribution from trade flows, ISTAT said.

It gave no numerical breakdown of components with its preliminary estimate, but said agriculture had expanded, services had stagnated and industry had declined.

Italian think tank Prometeia said that the only positive driver for Italy remains the flow of incoming cash from the European Union's post-COVID 19 Recovery Fund "which could account for almost all of the overall GDP growth this year".

However, in the midst of the economic stagnation, "on a positive note, the labour market remained resilient in September" said Paolo Pizzoli, senior economist at ING, commenting on separate data showing employment posting a monthly gain and the unemployment rate hovering around historical lows.

Italy's GDP figures showed so-called "acquired growth" at the end of the third quarter stood at 0.5%, ISTAT said.

This means that if there were to be zero quarter-on-quarter growth in the final three months, over the whole of 2025 GDP would increase by 0.5% from the previous year, in line with the government's latest target.

Rome earlier this month marginally lowered its forecast from an April projection of 0.6%.

(Reporting by Antonella Cinelli, graphic by Stefano Bernabei, editing by Gavin Jones)