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EURO GOVT-Bunds fall on Moody's negative German outlook
* Bund yields rise after Moody's changes German outlook
* Bund yield rise seen temporary
* Dutch bond sale meets lukewarm demand after Moody's threat
* Spanish yield curve begins to invert on bailout fears
By Kirsten Donovan
LONDON, July 24 (Reuters) - A rally in safe-haven German government bonds paused on Tuesday, with yields rising after credit rating agency Moody's revised its outlook for the country to negative, although the sell-off was not expected to last with pressure on Spain growing.
Spanish bond yields rose further, albeit at a slower pace than on Monday, but a successful sale of short-term debt offered little support as expectations grew the country will need a full bailout on top of an already approved rescue deal for its banks.
The potential cost to the so-called core euro zone members of Spain and Italy requiring further support was one of the reasons cited by Moody's Investors Service for changing Germany's outlook, as well as those of the Netherlands and Luxembourg, along with the cost of containing fallout from a possible Greek euro exit.
Greece's international lenders return to Athens on Tuesday to decide whether to keep the country on its 130-billion-euro life support line.
But analysts said with a "sizeable" investor base obliged to invest in euro-denominated assets, the Bund sell-off was likely to be temporary and they would remain the safe haven of choice.
"If we're to get to a solution to the debt crisis it can only be through fiscal unity which points to higher core yields and ratings potentially coming under pressure," said Richard McGuire, interest rate strategist at Rabobank.
"But in order to get to the point where core sovereigns assume the liabilities, things must get worse and that points towards lower yields in the short term, particularly for Germany."
With Standard & Poor's already assigning Finland a negative outlook, no euro zone country has a stable outlook on its triple-A rating from all three major credit agencies.
Bund futures were down 64 ticks on the day at 144.91 but off their earlier lows. Ten-year yields were up 6.5 basis points at 1.24 percent.
Traders reported selling of German paper by both long-term investors and "fast-money" accounts - such as hedge funds - as well as by dealers in early trading, but that had slowed down.
"There's a lot of "risk-off" out there - Spain and Italy of course but also selling of France and Belgium," one trader said.
"That's helped Bunds come back a bit already."
Bunds have underperformed both U.S. Treasuries and UK gilts this week, something one trader called an "anti-euro bias" and some of last week's yield hunt which saw demand for French, Belgian and Austrian bonds has been unwound.
"The buyers of France and Belgium are still around but the flows have slowed to a trickle," the trader said. "They'll step back in if things get better but it's looking pretty grim for now."
The Netherlands, which has benefited by offering relatively safe paper with a modestly higher yield than Germany, found it tougher than usual to sell bonds after the Moody's action. It sold just 1.76 billion euros of two- and 15-year bonds, the lower end of the target range and the smallest amount at any Dutch sale this year, according to Reuters data.
Spain paid its second highest yield to issue short-term debt since the introduction of the euro although analysts expressed cautious relief that the sale had gone smoothly.
"It is not going to reverse the generally weak trend that we have seen. The fears about the euro zone aren't going to go away...Bonos are a better reflection of investor demand," said Marc Ostwald, rate strategist at Monument Securities.
That demand has been minimal, sending Spanish bond yields to euro-era highs in illiquid conditions on concerns the government might lose access to debt markets and need a full bailout, which would drain the euro zone's currently available rescue funds.
Ten-year Spanish yields were 10 bps higher at 7.60 percent but five-year yields rose above 10- and 30-year yields for the first time since at least June 2001.
Short yields have risen more than longer-dated ones, flattening the yield curve, because of a perceived rise in credit risk, a pattern seen before Greece, Ireland and Portugal were forced into asking for aid.
Two-year yields were up 16 bps at 6.77 percent after rising almost a percentage point on Monday after media reports on Sunday that up to half a dozen local authorities were ready to follow Valencia in asking for government aid.
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