EURO GOVT-Greek relief dampens Italy, Spain bond yields
* Greek buy-back seen successful, eases IMF aid doubts * Spain, Italy bonds yields seen subdued into year-end * Bunds steady on U.S. budget concerns By Emelia Sithole-Matarise LONDON, Dec 4 (Reuters) - Italian and Spanish bonds edged up on Tuesday, with relief that Greece could be on its way to clinching its next aid tranche expected to underpin demand for higher-yielding euro zone debt into year-end. Although peripheral bonds outperformed Bunds, German debt clawed back some ground on signs U.S. lawmakers could be headed for an impasse in budget talks that could push the world's biggest economy into recession. Italian 10-year yields fell 4 basis points to 4.41 percent while the Spanish equivalent was last 2 bps lower at 5.22 percent, extending Monday's falls after Greece unveiled better than expected terms for a debt buy-back crucial for it to get bailout funds in coming weeks. The repurchase plan is part of a deal reached last week by Greece's international lenders to cut its debt pile, and it needs to be completed before the IMF can release its share of the aid. The buy-back terms improved the chance of success, prompting investors to keep piling into lower-rated euro zone bonds. Italy's borrowing costs fell to fresh 2-year lows and its 10-year yield premium over Bunds dropped below 300 bps for the first time since March. "We think that the big items such as an imminent bankruptcy in Greece are off the table. The overall climate is in favour of investors looking for yield everywhere and so the way of least resistance is for a narrowing of yield spreads," Piet Lammens, a strategist at KBC said. CHANGING MINDSET? With debt issuance petering out as 2012 draws to a close and Spain expected to eventually request aid that would trigger European Central Bank (ECB) bond buying, Lammens expected Spanish yields in particular to fall below 5 percent by the end of the year. Technical charts pointed too to further falls after the 10-year yield broke last week below the 5.30 percent level that had held over the past two months, which could likely see it fall to 4.85 percent if 5 percent is convincingly breached. "People are underinvested with their cash and with Europe looking a lot more stable that makes a fundamental difference in terms of people's mindsets," a trader said. "To be underinvested in high-yielding periphery costs you money. So I see more and more momentum going into year-end for the risk rally to continue." Greek bonds were slightly lower in price after Monday's sharp rally with details of the bond buyback due at the end of the week. German Bund futures were last seven ticks up on the day at 142.58 in choppy trading while cash 10-year yields were up half a basis point at 1.41 percent, well within their recent 1.30-1.70 percent trading range. Traders saw little scope for the yields to break the top of that range given concern over U.S. congressional gridlock over budget talks. Investors were doubtful that U.S. lawmakers will reach a deal in time to avert recession-inducing fiscal tightening in the world's biggest economy early next year after the White House dismissed proposals by Republicans for steep spending cuts. "The fiscal cliff debate rumbles on... The growth implications if they don't get something sorted out are fairly severe and as long as that remains in play, core markets remain reasonably well supported," another trader said.