UPDATE 2-Debt sale underscores Germany's safe-haven appeal
* Uncertainty before Greek election favours German debt
* Underscores confidence in credit quality of German debt
* Sharp sell-off in Bunds boosts appetite at sale
* German sale attracts 1.4 bid-cover, above year's average
LONDON, June 13 (Reuters) - Uncertainty before Greek elections prompted investors to pick up 10-year German bonds at a sale on Wednesday, easing niggling concerns about the country's credit quality as the euro zone debt crisis drags on.
A sell-off in German debt over the past two sessions also boosted demand for 4.04 billion euros of 10-year paper by cheapening bond prices and pushing yields higher.
The sale attracted bids worth 1.4 times the amount on offer, above this year's average and demonstrating the euro zone's largest economy is still able to borrow in times of market stress and at much lower cost than its peers in the bloc.
"There were a lot of questions going into the auction, with regards to this credit dilution story - Germany being increasingly exposed to the EMU risks - and the sell-off we've seen," Michael Leister, strategist at DZ Bank, said.
"But at least for now this auction will serve to calm down the worst fears the market was having going into the auction, and should help to somewhat stabilise Bunds."
German Bund futures last traded at 141.66, down 82 ticks on the day, compared with 141.50 before the sale.
Bunds have come under pressure over the past two days as markets absorbed long-dated supply from highly-rated issuers Austria, the Netherlands and the European Financial Stability Fund, and as investors took profit on recent huge gains.
The losses have prompted some questions about Germany's safe-haven appeal given expectations that any efforts to resolve the crisis will take a toll on its finances.
Germany paid an average yield at the sale of 1.52 percent, above the cost of funds it achieved at the previous auction but below this year's 1.764 percent average.
The head of PIMCO's German unit said on Wednesday that the increased liabilities Germany faces as a result of the crisis are eroding the attractiveness of its sovereign bonds, and that the world's largest bond fund had cut its Bund exposure.
"Does one want to invest at a negative real interest rate? Not necessarily," Andrew Bosomworth told reporters in Frankfurt. "Germany is losing quality due to the increasing conditional liabilities that are piling up on the Bund."
Annual consumer price inflation in Germany is running at 1.9 percent, meaning the real Bund yield is negative.
EU paymaster Germany shoulders the biggest cost of financing the bloc's bailout funds, which are already supporting Greece, Portugal, Ireland and will soon funnel aid to Spain too after weekend a deal to lend Madrid up to 100 billion euros. A euro break-up would also be costly for Germany.
But analysts said the auction showed Bunds were still the favoured asset in the euro zone as investors seek to preserve their capital in a volatile environment.
The bid-to-cover ratio was below the 1.5 seen at a previous sale in May but above an average of 1.34 for similar auctions this year. Some felt the result could have been better, however, given the scale of the recent sell-off.
"They built one of the biggest concessions we have ever seen for a 10-year auction," said Marc Ostwald, strategist at Monument Securities. "It's been a lot better than some of the really bad 10-year auctions that we've had, but 1.4 ... is hardly overwhelming given the size of the concession."
The debt sale comes just days before Greeks go to the polls in a vote that will be decisive for Greece's future in the euro and as investors worry about Spain's long-term ability to access markets.
A bank bailout deal has done little to boost investor confidence in Spain, whose borrowing costs are currently hovering near euro-era highs, fuelling concerns that contagion may spread to Italy - the euro zone's fourth largest economy.
Italy's one-year borrowing costs shot up to a six-month high of 3.972 percent at an auction on Wednesday.
It will face a stiffer test on Thursday when it offers three-year bonds and two longer-dated issues no longer sold on a regular basis, for a total of up to 4.5 billion euros.
Against an increasingly uncertain backdrop, German bonds are expected to remain underpinned in the near term even though analysts increasingly question their value, given the ultra-low yields on offer.
"Certainly fundamentals don't justify the current level of low yields but we rule out that markets have shifted to a sustainable sell-off mode," Annalisa Piazza, market economist, Newedge Strategy said. "
"Uncertainties about details of the Spanish banks loan and the outcome of the Greek elections are still looming."
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