EURO GOVT-Bunds rally as peripheral and U.S. worries take hold
* Bunds rise by a full point in nervy market
* Italy worst peripheral performer ahead of Thurs auctions
* Concerns over scope of rescue fund enhancements grow
LONDON, July 27 (Reuters) - Investors snapped up safe-haven German Bunds on Wednesday as doubts about the Greek rescue deal and rising U.S. default risks drove prices back to levels seen before Europe's leaders acted to halt the spread of the euro zone debt crisis.
Concerns about the implementation of plans to bail out Greece were exacerbated by conflicting signals out of Athens and Berlin which highlighted the political divides still dogging euro zone markets.
This came against a background of nervy markets as the United States faced a possible default and ratings cut, sending German Bund futures FGBLc1 more than a point higher.
"It's been a day of two halves; this morning's moves were all about trades out of Italy and Spain and this afternoon it's been everyone sweating about the U.S. debt deal -- each of which has added about half a point onto Bunds," a trader said.
The rally in German paper saw yields between U.S. Treasuries diverge, pushing the premium investors demand to hold Treasury debt rather than Bunds to 32 basis points -- the highest since February.
Greece's credit rating was cut by rating agency Standard and Poor's to CC with a negative outlook after the market close on the grounds that its restructuring proposal options appeared to be unfavourable to investors.
Elsewhere among the euro zone's lower-rated debt, Italy was the worst performer with 10-year yields up around 13 basis points at 5.78 percent as investors priced in a concession ahead of debt auctions scheduled for Thursday.
Spain was also under pressure with 10-year yields slightly up on the day and hovering around the 6 percent mark, above which investors become nervous about funding stability.
Analysts said this demonstrated concerns about last week's deal to rescue Greece and ringfence the region's debt problems.
"The summit deal last week is not exactly coming apart, but certainly showing where it was light on substance; on Italy and Spain, for example, and whether the deal has sufficient resources, the concern is patently clear," said Chris Scicluna, deputy head of economic research at Daiwa Capital Markets.
Last week's deal from European leaders gave the European Financial Stability Facility new powers to intervene in secondary bond markets, and provide credit lines to banks and sovereigns not in receipt of bailout funds. However there was no increase in the rescue fund's current 440 billion euro capacity.
That meant peripheral yields were likely to face continued pressure over the European summer until the plans were fleshed out, analysts said.
"Provide more resources ... that's ultimately the solution that has to be found to be able to reassure the market that you are standing behind Italy," Scicluna said.
"The question is whether or not it is possible to provide such a large amount without putting at risk the ratings of core countries."
U.S. BACKDROP NERVOUS
Continuing stalemate between politicians in the United States over raising the country's debt ceiling has investors preparing for a temporary default scenario and possibly a longer-term ratings downgrade.
That uncertainty was supporting German Bunds, although there was no sign that Treasury holders were ditching U.S. debt in favour of Bunds on a large scale, market participants said.
"There's obviously a bit of concern out there and Germany as one of the major triple-As will benefit from that," said Brian Barry, analyst at Evolution Securities.
"Different funds will have different mandates, but if it is within their mandate to switch currencies they may look to be more cautious on the U.S. until we get some clarity."
That should keep the U.S./German spread pushing wider in the near term, but analysts said there would be a kneejerk rally in Treasuries, narrowing the gap, if U.S. politicians were able to reach a deal and avoid default. (Editing by Susan Fenton)
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