EURO GOVT-Italian yields ease as Monti seeks to form govt
* Italian yields ease as Monti named to head govt
* Three billion euro debt sale next test
* Bunds hold up with crisis far from over
LONDON, Nov 14 (Reuters) - Italian government bond yields edged lower on Monday before an auction that will test appetite for the country's debt after the appointment of a new head of government offered at least temporary relief to the bond market.
Following former Prime Minister Silvio Berlusconi's resignation, Italian President Giorgio Napolitano asked former European Commissioner Mario Monti on Sunday to form a government to restore market confidence.
"From the political side this is the critical foundation Italy needs to regain credibility in the market," said Norbert Aul, rate strategist at RBC Capital Markets.
"From here the work has to continue and we need to see austerity measures and structural reforms put in place but the challenges remain basically the same."
The political change was mostly priced into the market last week, helping bring yields across the Italian curve back below 7 percent. Italy will auction up to 3 billion euros of five-year bonds with the relatively small size expected to be sold, albeit at a high price.
"The bond auction should go fine in this environment," a trader said. "We expect to see it come through the market level, wherever that is at the time, although it will still be expensive for them in outright terms.
Benchmark Italian 10-year yields were 7 basis points lower at 6.43 percent after hitting a euro-era high of 7.5 percent last week, with five-year yields 11 bps lower at 6.42 percent.
However, any relief from the euro zone debt crisis may be short-lived with efforts to construct a financial firewall to protect Italy, Spain and potentially France struggling to overcome legal and political obstacles.
Monti's appointment came after Greece appointed former European Central Bank vice president Lucas Papademos as prime minister, easing fears the country could drop out of the euro zone.
"In short, the market can be more confident in the ability of Greece and Italy to pass the necessary fiscal measures to regain control of their debt, but the economic and structural issues facing the euro zone remain a problem," said Credit Agricole CIB rate strategist Peter Chatwell.
With the crisis far from over, December German Bund futures were nine ticks higher at 137.35, although more than 2 points below last week's record high of 139.58.
UBS technical analyst Richard Adcock said that despite the fall, there was no evidence of bearish reversal patterns forming and that while the contract held above 137.02 -- the 38 percent retracement of the October to November recovery -- the market could rise back above the 138.25 level to retest the highs.
Benchmark 10-year German yields were down 1 basis points at 1.873 percent.
Later in the day the ECB will announce how much it spent buying peripheral debt -- mainly Italian bonds -- in the secondary market in the week until last Tuesday.
The ECB was said to have stepped up its purchases towards the end of last week but this will not be included in Monday's figures.
Analysts expect the central bank buying to continue this week in the face of heavy supply, with Spain and France holding auctions on Thursday.
ECB officials including Bundesbank President Jens Weidmann reiterated it was not up to the central bank to solve the debt crisis and that it was up to governments to implement the necessary reforms.
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