REFILE- EURO GOVT-Worries over banks, funding costs hit Spanish bonds
* Bund futures hit record highs; Spanish yields up
* Concerns revolve around Spain's banks and funding costs
* Some investors take profit on Bunds
By Marius Zaharia
LONDON, May 17 (Reuters) - German Bund futures hit record highs and Spanish bond yields rose on Thursday as concerns about Spanish banks and the rapid rise in Madrid's borrowing costs kept investment flows directed towards perceived safe havens.
A Spanish auction, strongly supported by domestic banks which placed bids at market levels, did not add to selling pressure but also did little to change broad views that Spanish yields are likely to rise further in coming weeks.
Borrowing costs rose by more than one percentage point for two of the three bonds that were sold and this is a major concern, suggesting they are rapidly heading to unaffordable levels.
Also, Greece's political crisis has heightened anxiety and Spanish banks under pressure to make provisions for bad property loans may not be as willing to spend money on government debt as they have been earlier this year.
"There must be significant risks for (Spain's) borrowing costs over the next weeks or months. A lot will depend on what happens in Greece," Chris Scicluna, head of economic research at Daiwa Capital Markets
"The first line of defence might be the European Central Bank reintroducing its securities markets programme ... it may not happen until 7 percent for the 10-year. That would be the obvious one that would ring alarm bells."
Spanish 10-year yields were last 7 basis points higher at 6.38 percent, its five-year yields were 8 bps up at 5.47 percent, while two-year yields rose 10 bps to 4.23 percent.
Ten-year yields have risen by around 15 bps per week on average since the beginning of March, when Spain agreed a higher 2012 budget deficit target with the European Union.
With one month to go until new Greek elections, some analysts fear that yields could soon reach the panic-triggering 7 percent, beyond which countries like Portugal or Ireland have been shut out of bond markets.
Greek leftists opposed to the terms of the country's international bailout package are expected to do best in the ballot and this raises fears that Greece will default and may even crash out of the euro zone.
In Italy, another country which is vulnerable to contagion from the Greek crisis, 10-year yields were 8 bps higher at 6.06 percent.
Bund futures hit record highs again, rising as high as 143.79, up 61 ticks on the day.
The air gets thinner around those peaks, though. Russell Silberston, who manages around $30 billion worth of fixed income assets as head of global interest rates for Investec AM, said he has been selling Bunds for the past few weeks.
"We think Bunds are horribly expensive. If we get some sort of solution like common bonds for example ... we can see a big sell-off," he said. "The risk-reward is such that we have been taking profits on those and sitting neutral."
Silberston has bought French bonds this week, seeing an opportunity in the recent widening of French/German yield spreads. He also remains exposed to Dutch and Finnish bonds as he thinks those countries can pay back debts even if the euro zone breaks up.
"It is a credit decision at the end of the day. Are we going to take our money back if we invest in those? I think so," Silberston said.
Futurestechs technical analyst Clive Lambert expected Bunds to hit new record highs soon, however. The next resistance level is at 145.02, the top of the channel formed by the session highs and lows during the rally kick-started in mid-March at levels between 135.00 and 136.00.
"The bulls are still in the box seat and all is good in their world," Lambert said.
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