EURO GOVT-Bunds up, peripherals hurt on bank funding worries

* Bank funding worries elevate risk aversion

* Bunds up, peripheral spreads widen to May 10 highs

* Spanish sovereign, Iberian bank CDS rise

* Central banks hoover up Greek month-end bond sales

(Updates to settlement)

By Kirsten Donovan

LONDON, June 29 (Reuters) - German Bunds hit three-week highs on Tuesday, buoyed by 10-year U.S. Treasury yields falling below 3 percent, lower stocks and unease over bank funding ahead of a half trillion euro repayment to the European Central Bank.

Peripheral euro zone yield spreads widened, with Portuguese and Irish spreads over Bunds briefly hitting their highest since May 10 when the ECB began buying peripheral bonds.

Meanwhile, Spanish credit default swaps hit a record high 277 basis points on concerns over banks' funding situation when 12-month loans are repaid to the ECB on Thursday, despite banks being able to roll the funding into three-month loans.

Credit default swaps on Spanish banks --one of the biggest users of the ECB's lending facilities - were around 15 basis points wider, according to data monitor Markit, with the cost of insuring against a default by Portugal's Banque Espirito Santo 40 basis points wider.

"If there's a very big roll, the inference the market may make is that banks can't fund anywhere apart from at the ECB," said Morgan Stanley rate strategist Laurence Mutkin.

September Bund futures FGBLc1 settled 23 ticks higher at 129.43 Earlier they reached 129.86, just shy of the contract high of 129.93 struck on June 8.

The 10-year U.S. T-Note yield US10YT=RR fell to 2.956 percent in Europe, its lowest level since late April 2009, pulling Bunds down in its wake. Two-year Treasury yields US2YT=TWEB hit their lowest level on record at 0.59 percent.

"It's the risk-off theme," said a trader. "Bunds and Treasuries are doing well, everything else is getting hammered." The 10-year Bund yield DE10YT=TWEB was down 2.6 bps at 2.562 percent, having fallen as low as 2.526 percent. The two-year Schatz yield DE2YT=TWEB was down 1.3 basis points at 0.557 percent.

European shares .FTEU3 fell to their lowest in nearly three weeks with grim data on U.S. consumer confidence fuelled worries over the economic recovery.

BUNDS OUTPERFORM T-NOTES

Ten-year U.S. Treasuries yielded 43 basis points more than Bunds, as German debt outperformed in Europe, widening the spread from 39 bps.

"Although Bunds may outperform Treasuries in the short term ... we would rather use any Treasury-Bund widening as an opportunity to build a position for tightening," said David Keeble, rate strategist at Credit Agricole.

"The refi fears will pass. Think of the current widening of peripheral spreads as being an auction concession."

Greek/German 10-year bond yield spreads remained steady at around 810 basis points as month-end selling began related to the bonds fall out of indexes such as iBoxx, Citigroup and Barclays Capital. [ID:nLDE65E0LK]

"We think that 15-20 billion euros of Greek debt will be forced selling on Wednesday," said Giovanni Zanni, European economist, Credit Suisse, in Paris. Traders said the selling by indexed funds had begun on Tuesday afternoon, and was being met by central bank buying.

(Editing by Ron Askew)