EURO GOVT-Bunds fall despite auction, Italian sale next up
* German bonds extend sell-off, multiple factors cited
* Italian yields rise before Thursday's debt auction
* Contagion fears could make Italian sale challenging
LONDON, June 13 (Reuters) - German bond prices fell on Wednesday extending a two-day sell-off helped by profit-taking, even as decent demand at a 10-year bond auction underscored the debt's safe-haven appeal before Greek elections this weekend.
Italian government bonds also came under pressure one day before The Treasury 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.
The Italian auction may be a challenge at a time when analysts are worried about contagion from Spain. A bailout agreed for Spanish banks did little to soothe concerns that it may eventually lose access to commercial markets.
"Tomorrow's auction will be under the spotlight. The market is (watching) to see how much room there is for the Italian Treasury to fund the current budget," Sergio Capaldi, strategist at Intesa SanPaolo. "They know that they have to pay a tad more to get market demand."
Italian 10-year government bond yields by late European trading stood 5.3 basis points higher at 6.22 percent, reversing earlier falls as nerves set in before the bond sale, according to traders.
The Spanish equivalent at 6.77 percent hovered near euro-era highs and were up 2.7 bps on the day.
German Bund future saw another day of heavy selling, despite widespread uncertainty before Greece's election over the weekend and decent demand at a German auction earlier in the day. It saw a settlement close of 141.71, down 77 ticks on the day.
Analysts have been scratching their heads to explain the move lower in the Bund, with some pointing to profit-taking on hefty gains made recently and others to a bout of long-dated supply from highly-rated Austria, the Netherlands and the European Financial Stability Fund.
German Bund futures in May locked in 3.5 percent of gains after a vote in Greece resulted in political deadlock and as concerns over Spain's ability to recapitalize banks without running out of funds grew. The Bund is up 2 percent so far this year after an 11 percent rally in 2011.
Traders also pointed to changes in Danish pension fund rules as an additional technical factor reducing demand for longer-dated German debt.
The losses however have prompted some to wonder whether contagion is finally spreading to Germany on the view that it will pay a high price for whatever the outcome of the euro zone debt crisis.
While demand at a sale of 10-year German debt helped ease tentative worries about the regional powerhouse's credit quality, some analysts said the debt sale could have been better given how much prices had cheapened ahead of time.
"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."
But, for now, analysts expected safe-haven Bunds to rebound and continue to benefit from an uncertain backdrop, especially before the Greek vote on Sunday.
If Greek voters once again vote out parties in favor of austerity in exchange for bailout cash, the country could quickly run out of funds and could come under pressure to leave the euro.
A euro zone break up would have unmeasurable consequences for other member states including the biggest economy, Germany, whose export-led economy greatly benefited from the single currency.
Those concerns are likely to make investors reluctant to take the Bund sell-off much further, some said.
Ten-year German bond yields rose 7.1 bps to 1.50 percent, off but still within sight of historical lows of 1.127 percent.
"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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