EURO GOVT-Italian yields at lowest in nearly 2 years before sale
* Ten-year Italian yields fall before debt auction
* Spanish yields at lowest since mid-March
* After Greek deal, improved periphery sentiment continues
LONDON, Nov 29 (Reuters) - Italian bond yields fell to their lowest in nearly two years on Thursday before a sale of five- and ten- year bonds, with market participants divided on how the sale will fare given the recent bond rally.
The Italian treasury is seeking to place up to 6 billion euros of the bonds at an auction that could bring Rome within reach of its 460-465 billion euros ($594-$600 billion) 2012 borrowing target.
Improved sentiment towards riskier euro zone debt after a deal on the next tranche of Greek aid this week should provide a favorable backdrop to the sale but has, at the same time, fueled a rally in Italian debt, making it more expensive before the auction.
Italy paid less than 1 percent on Wednesday to sell six-month bills - its lowest in more than two years.
"The sentiment for European periphery is definitely very strong. It has been strong for a while but further strengthened by what's happening in Greece," a trader said.
"A market that rallies into an auction is usually a sign that there is strong underlying demand. There is every indication that the auction will go very well because there is no shortage of buyers."
Italian borrowing costs over ten years fell 10 basis points to 4.49 percent. Five-year Italian yields fell 11 bps to 3.18 percent.
But not all analysts expected such a stellar outcome.
"The auction will probably clear okay but it won't be a strong auction," Artis Frankovics, strategist at Nomura said, explaining that the recent price gains had made the bonds less attractive than previously.
Spain's borrowing costs over ten years followed suit, hitting their lowest since the middle of March at 5.21 percent.
"Looking out over the medium-term we would expect 10-year Spain to remain trapped within (the) 6.15 and 5.26 (range) with the bias probably to sell Spain on any drop in yields down to trendline support again at 5.26 percent," Credit Suisse technical analysts said.
U.S. FISCAL LIMBO
U.S. House of Representatives Speaker John Boehner said on Wednesday he was "optimistic" on reaching a budget deal before the end of the year to avoid a crisis, underpinning global equities overnight.
Signals from lawmakers, however, have been mixed, and markets were expected to remain sensitive to any comments on the progress of talks in the United States to avert $600 billion worth of automatic tax hikes and budget cuts next year.
"It's the biggest single factor between now and the end of the year in terms of moving the market. Bond markets are pretty thin and (the danger is) we react to every headline/soundbite," a second trader said.
For now, German bonds were taking their cue from higher equity markets, and Bund futures fell 24 ticks on the day to 142.71.
But there was still some upside until the contract met technical resistance, some said.
Credit Suisse technical analysts said they saw a resistance zone for the December Bund future between 143.48 - the November high and 143.65 - the 61.8 percent retracement from the highs in May-June.