EURO GOVT-Spanish yields turn lower as downgrade impact fleeting

* Spanish bonds recover early post-downgrade losses
* Losses tempered by unwillingness to go short while ECB
waits
* Italy bond auction finds solid demand but yields higher

By Ana Nicolaci da Costa
LONDON, Oct 11 (Reuters) - Yields on Spanish government
bonds turned lower in late trading on Thursday as investors
bought back into a cheapened market after a sell-off in early
trading that was due to an overnight downgrade by rating agency
Standard & Poor's.
Analysts also said that given the prospect of potentially
unlimited European Central Bank bond buying, if Spain asks for
aid, it was difficult for investors to have selling positions on
the Spanish sovereign debt market. Instead, any rise in yield
was being seen as an opportunity to buy back in.
Standard and Poor's cut Spain's rating to BBB-minus with a
negative outlook, just one notch above junk grade and in line
with peer Moody's, which is expected to conclude its own review
of the country's rating soon.
"You have got this circularity to it - the more the yield
goes up, the more likely it is you get more buying coming from
the ECB. It's very difficult to really punish that market,"
David Keeble, global head of fixed income strategy at Credit
Agricole said.
Central bank bond buying is dependent on Spain asking for
aid, which it has been reluctant to do, but the promise of
intervention has been enough to keep Spanish yields within a
tight range in recent weeks.
Ten-year Spanish yields fell 4.4 basis points
to 5.78 percent, having earlier risen as high as 5.96 percent.
Two-year bond yields meanwhile were down 5.3 bps to
3.27 percent, off the session high of 3.58 percent.
"There has been a massive buyer from the U.S. who seems to
have caught the market out. There was some ... selling this
morning after the S&P downgrade but now a lot of people have
been caught short and squeezed. We saw buying at the front end,"
a trader said.

COUNTING ON THE BACKSTOP
The S&P move raises the likelihood that Spain could be rated
below investment grade by two agencies in the near future, which
would cause it to drop out of some major bond indices and force
selling by investors who track such benchmarks.
The fleeting market impact of the downgrade underscores the
psychological impact of the ECB's intervention promise which
also underpinned demand at a sale of Italian bonds earlier,
analysts said.
Italy sold 6 billion euros of bonds at auction, paying a
higher price to sell three-year debt than a month ago but still
finding solid demand.
"Yields were a bit higher but not particularly elevated so
all in all it went pretty smoothly," said Nick Stamenkovic,
strategist at RIA Capital Markets in Edinburgh.
"I think it's the expectation that the ECB continues to
provide a backstop for not just Spain, but Italy as well,
further down the road."
In the secondary market, ten-year and two-year Italian bond
yields were also lower at 5.03
percent and 2.48 percent respectively.
German Bund futures were down 8 ticks on the day at
a settlement close of 141.15, coming under slight pressure in
tandem with their U.S. counterparts.
U.S. government debt prices fell on Thursday as traders
sought to lower prices before a $13 billion auction of 30-year
supply and encouraging data on jobless claims reduced safe-haven
demand for bonds.