EURO GOVT-Investors snap up Bunds after sharp sell-off
* Bunds rebound after last week's big sell-off
* Further falls seen likely on improved U.S. outlook
* Euro zone data, ECB may be next market movers
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, Jan 7 (Reuters) - Investors snapped up German Bunds on Monday, after the euro zone's lowest-risk debt tumbled to one-month lows last week, even though fresh falls were expected on a cautiously upbeat outlook for the U.S. economy.
Bunds clawed back some ground against higher-yielding Spanish and Italian bonds, which had benefited from a rally in riskier assets after U.S. politicians reached a last-minute deal to avert a fiscal crisis in the world's largest economy.
Figures on Friday showing the U.S. services sector grew in December at its fastest pace in 10 months and concerns that the Federal Reserve could end its bond purchases earlier than many initially thought spurred the sell-off in Bunds last week.
Bund futures fell by almost three points last week to their lowest in a month at 142.52. On Monday, at the start of the first full week of trading of 2013, they rebounded by 31 ticks to settle at 143.06.
"They're cheap so you have to buy them while you can. The sell-off last week was very heavy ... and then there have been quite a few recommendations to buy them around the 1.50 (percent yield) level," a trader said.
Analysts saw more setbacks for Bunds in the near term as an improved U.S. outlook and relative calm in the euro zone provide a favourable environment for yield hunting.
"There's an overall tendency to say goodbye to safe-haven assets and pick up yield somewhere. If you just keep on holding your safe-haven assets you will somehow bleed to death," said DZ Bank rate strategist Christian Lenk.
"Even if you don't see very positive news in the next few weeks I could well imagine we will see lower levels in the Bund and a return to yield levels where we've seen resistance in the past ... the 1.60-1.70 percent area is crucial."
Risks to that scenario stemmed from a potentially bitter Italian election campaign and knife-edge debates about lifting the U.S. debt ceiling, he said.
Cash German 10-year yields were last 3 basis points lower on the day at 1.52 percent. Significantly, they broke above 1.46 percent last week - a level they repeatedly failed to break in November and December - signalling yields were likely to rise further.
The slight rebound may also reflect caution before a spate of euro zone data, debt sales, and a European Central Bank policy meeting later this week, at which the bank is seen holding fire and may back away from the easing signals sent last month.
This week's euro zone releases include unemployment, retail sales and some business sentiment indicators.
"Some of the data has been, on the margins, better in Europe and therefore the urgency for the ECB (to cut rates) is not there," said RBS strategist Harvinder Sian.
"Nevertheless the economy still remains very weak and in that context the market will over the course of the quarter look at the rate cut debate, and that does anchor yields in the short term."
Among peripheral euro zone bonds, Italian 10-year bond yields rose 8 bps to 4.35 percent with equivalent Spanish yields up 5.5 bps to 5.12 percent as traders pushed for lower prices before debt sales later in the week.
The main focus will be on Spain's auction of 4-5 billion euros worth of bonds on Thursday. That will start the most challenging funding programme in the bloc this year, which could push Madrid into requesting a bailout soon though Prime Minister Mariano Rajoy has so far given little sign that he is willing to do that.
Barclays strategists saw a 60 percent probability that Spain would seek precautionary aid and maintained their recommendation of buying shorter-dated Spanish bonds.