EURO GOVT-Pressure on Rajoy rattles Spanish bonds
* Spanish and Italian yields rise as political risks grow
* Looming Spanish bond sale adds to selling pressure
* Bunds rebound but remain lower after late Friday selloff
LONDON, Feb 4 (Reuters) - Spanish government bond yields rose sharply on Monday as investors grew wary that mounting political uncertainty could derail this year's rally and the pressure of upcoming bond auctions exacerbating the selloff.
In Spain, Prime Minister Mariano Rajoy was facing calls to resign over a corruption scandal in which he denies any wrongdoing.
Traders also cited the growing popularity of Italian former premier Silvio Berlusconi, who stepped down in 2011 with Italy in the middle of a full-blown economic crisis, as a big worry for investors before elections this month.
Spanish 10-year government bond yields rose 20 basis points to 5.42 percent while Italian yields were 9 bps higher at 4.42 percent.
"It's that worry of political instability in both Spain and Italy," a trader said. "Rajoy is under a bit of pressure and Berlusconi seems to be making a good old comeback in the polls as well."
"A lot of people have been bullish Spain and Italy for a few months and it's come a long way but there's a lot of supply to get through and a lot of the early-year money has gone to work."
Peripheral debt has started the year strongly, aided by the plentiful supply of cash from central banks and the promise that the European Central Bank will step in and buy bonds of struggling states if necessary.
However, Commerzbank strategists said the time was right to start cutting back investments in peripheral debt as current low yield levels tested technical supports and the Spanish political risks mounted.
The selloff hit sovereigns right across the region's periphery of weak states, with Irish, Greek and Portuguese bond yields also moving higher on the day, but an upcoming sale of Spanish bonds on Thursday exaggerated the selloff there.
"There's probably not enough in terms of two-way flow to absorb the selling that's occurring, which means that yields rise and spreads widen. There'd be a reluctance from dealers to get too long given the supply that's coming later in the week," said Peter Chatwell, strategist at Credit Agricole in London.
Spain will sell bonds maturing in 2015, 2018 and 2029.
German Bund futures, often used as a hedge against a flare-up in the region's weaker sovereigns, trimmed early losses when Spanish and Italian bonds started trading but, at 141.90, remained 11 ticks lower than at Friday's settlement.
Much of that fall can be attributed to a steep selloff in U.S. Treasuries late on Friday after jobs and manufacturing data showed recovery in the world's largest economy remained on track.
"Sentiment still remains pretty negative for Bunds. We're testing support around 1.7 percent. To get through that level we're going to need to see further signs of improving sentiment towards the euroland economy," said Nick Stamenkovic, strategist at RIA Capital Markets.
Any rally in Bunds was likely to be used by others as a chance to sell but the potential for another major selloff remained limited due to the sheer scale of recent falls, Stamenkovic said.
The 10-year German yield was last at 1.68 percent, 1 basis point higher on the day and 31 bps up compared to levels seen on the final trading session of 2012.
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