* FTSEurofirst 300 index up 0.6 pct
* Italy gains after Italian bond auction
* Tesco cheers as consumers spend
By Joanne Frearson
LONDON, Dec 28 (Reuters) - European shares rose on Wednesday in a low volume rally after investor sentiment was given a boost as short-term debt costs halved at a debt auction in Italy and improved confidence about demand for Thursday's Italian long-term bond sale.
Low volume made movements choppy and shares earlier dipped into negative territory on concerns about demand for the auction, before recovering as a closely-watched technical indicator suggested "oversold" conditions.
The Relative Strength Index (RSI) for the euro zone's blue chip Euro STOXX 50 index slipped to 21.17 on the intraday minute chart. A reading of 30 or below is considered "oversold."
The market continued gaining after the auction, with Italian bank Intesa Sanpaolo ISP.MI, whose movements are highly correlated to bond yields, up 1.6 percent and featuring as a top performer, while the Italian FTSE MIB gained 0.9 percent.
The short-term auction helped to ease investor worries that thin liquidity would make Thursday's sale of up to 8.5 billion euros of longer-term Italian bonds difficult.
Analysts also said a new austerity package and cheap long-term liquidity from the European Central Bank helped improved investor sentiment.
"There is a slightly better supportive tone to the bond markets in the euro zone and I should expect tomorrow's auction should be favourable," Mike Lenhoff, chief strategist at Brewin Dolphin, said.
"Italy has been directing itself towards getting austerity measures in place which has been improving sentiment and the ECB cheap money to banks is a plus as it can be used to support the market."
But 10-year Italian bond yields still remain at high levels and dangerously close to 7 percent, roughly the threshold beyond which other euro zone governments have been forced to seek bailouts.
Markets are likely to get increasingly nervous if yields stay above that level for a prolonged period when trading picks up early next year.
"Investors are acutely sensitive to Italy's ability to maintain market access, so it's not surprising that even during the Christmas lull the main event for the markets is a pair of Italian bond auctions," Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.
"Given the scale of its funding requirements, there are still big concerns about Italy's ability to get through 2012. Next quarter is going to be all about Italy."
By 1231 GMT, the pan-European FTSEurofirst 300 index of top shares was up 0.6 percent at 996.05 points, after being as low as 985.31. But volume was only 16 percent of the 90-day daily average.
UK retailers were among the best performers, with Tesco rising 2.5 percent, taking the top spot on the FTSEurofirst 300 index, after market researcher Experian said key post-Christmas sales, were similar to 2009.