EURO GOVT-German bonds in demand as Greece caution persists
* Greek default risk eased but aid doubts support Bunds
* Negative yield at Schatz sale underscores safety bid
* Italy hits auction target despite risk-averse mood
LONDON, Nov 14 (Reuters) - Demand for low-risk German debt held firm on Wednesday, underscored by a sale of two-year bonds at a negative yield, as wrangling over Greek aid payments keeps investors on edge.
Triple-A rated Germany sold 4.3 billion euros of a new two-year bond that pays no interest, meaning Berlin is effectively able to borrow for free because investors prize the country's strong fiscal position and highly liquid debt market.
Bidding at the auction was strong, pushing the yield below zero. This reflected the recent shift back into safe-haven assets caused by a revival of concerns over Greece, uncertainty over whether Spain will seek a bailout and the prospect of slow economic growth.
"It's a combination of worries about the euroland economy plus ongoing fiscal concerns in Greece keeping the short end of the German curve underpinned," said Nick Stamenkovic, strategist at RIA Capital Markets in London.
While Greece is thought to have averted a near-term default after selling bills on Tuesday, international lenders disagree on how Athens can bring its debt down to a sustainable level, and a deal to release aid payments remains some way off.
"The final decision on the release of the next aid tranche is delayed, which makes for pretty strong headline risks. All this suggests Bunds will remain underpinned at these lofty levels," said Commerzbank strategist Michael Leister.
German 10-year debt futures held broadly steady at their elevated levels, down five ticks on the day to 143.09 but looking set to remain close to the two-month high at 143.48 hit on Tuesday.
SMOOTH ITALIAN SALE
Despite the risk averse mood, Italy -- one of the euro zone's struggling peripheral states -- was able to hit its target of five billion euros with an auction of three-, 11- and 17-year paper.
While Italy's high debt levels and political landscape remain of concern for investors, yields on its bonds are well below their highs thanks to the European Central Bank's promise to support the periphery if necessary.
"The result of today's auction underscores the externally driven resilience of Italy's bond market. Demand was solid and the yield on the three-year note resumed its downward trend and is at pre-crisis levels," said Nicholas Spiro, managing director at Spiro Sovereign Strategy.
Italian bonds had rallied in the run-up to the sale, but the bid to cover of 1.5 on the three-year paper fell short of expectations and the bonds subsequently trimmed their gains.
The Italian 10-year yield last stood 2 basis points lower on the day at 4.96 percent compared to a session low of 4.92 percent.