EURO GOVT-Bonds drop before supply as equities gain

* Bunds drop ahead of heavy issuance calendar

* Portugal to issue debt as final austerity vote scheduled

* Equities boosted by Wall Street, China export data news

* Spain in focus as interbank funds reported drying up

By George Matlock

LONDON, June 9 (Reuters) - Core euro zone government bond prices fell on Wednesday, weighed down ahead of 8.5 billion euros of supply from Germany and Portugal and by gains by European equities .FTEU3 and signs of strong Chinese exports.

European stocks halted a sharp three-day retreat after a late rally on Wall Street overnight .GSPC. Shanghai stocks .SSEC gained 3 percent as sources reported stronger than expected Chinese export growth in May, easing fears the European debt crisis might hit the Asian country's economic growth. [ID:nTST000207]

Germany will issue 6 billion euros of 2012 Schatz paper and up to 1 billion euros of 2020 inflation-proof bonds, while Portugal will sell up to 1.5 billion euros of 2013 and 2020 bonds. A final vote on the Portuguese's government's austerity measures will also take place in parliament on Wednesday.

"We will be downbeat today with all the supply to get through. Although Portugal is likely going to rubber-stamp the austerity measures and it should be positive for Portuguese bonds, it won't result in a tightening of spreads as this is only the first stage of austerity measures the country has to endure," said a trader in London.

The 10-year Portuguese OT yield spread over Bunds remained steady at 280 bps PT10YT=TWEBDE10YT=TWEB.

By 0734 GMT, the September Bund future FGBLc1 was down 33 ticks at 129.47 versus the settlement close on Tuesday.

The now-expired June contract hit a record high level of 130.37 on Tuesday before the rollover to the September contract.

The two-year Schatz yield EU2YT=RR was up 1.4 basis points at 0.473 percent. The bond hit a record low of 0.371 percent in May but scaled 0.52 percent earlier this month and since then has cheapened ahead of the auction this session.

The 10-year Bund yield EU10YT=RR was up 1.1 bps at 2.544 percent.

FOCUS ON SPAIN

A report of Spanish banks being frozen out of the European interbank market, affecting all but the biggest institutions, were seen as negative for Bono issuance though short-dated bond auctions should be unaffected.

Spanish newspaper Cinco Dias reported the situation had worsened for the banking sector in general since the start of the week. [ID:nLDE658046]

Ten-year Bono yield spreads tightened marginally to 211 bps from 212 bps on Tuesday ES10YT=TWEB.

Any credit impasse for Spanish banks could have a negative impact on demand at auctions because domestic institutions are the main buyers of those bonds, while the European Central Bank is focused on buying other peripheral debt, such as Greece, Portugal and Ireland.

Spain issues up to 4 billion euros of new 2013 maturity paper on Thursday. [ID:nLDE6561GE]

"The reports have been around for a while and are not a problem so long as the ECB continues to pump money into the system," said Marc Ostwald, a bond strategist at Monument Securities in London.

"But the problem becomes more serious when Spain wants to issue long-dated Bonos. The ECB should consider reintroducing 12-month refi tenders when the current operation ends later this month," he added.

Germany and France urged the European Commission to consider an EU-wide ban on short selling of shares and sovereign bonds in a display of solidarity that may ease concerns over recent Franco-German policy splits. [ID:nLDE6580AA]

In a joint letter published by Berlin on Wednesday, Chancellor Angela Merkel and French President Nicolas Sarkozy told European Commission President Jose Manuel Barroso the EU executive needed to accelerate efforts to impose tougher controls for credit default swaps on sovereign bonds and short selling, and present measures in the next few weeks.

"The market will be sanguine about this because while it may be a bond negative for a day or two, EU policymakers have no concerted policies to offer and are going around in circles rather than combating the problems," Ostwald added.

(editing by John Stonestreet)