EURO GOVT-Spanish yields dip but rebound fragile
* Italian, Spanish bonds firm; buyers nibble at cheapened debt * Periphery still shaky on nagging political concerns * Slightly dovish ECB tone underpins demand for Bunds * Irish bonds firm on brighter outlook after bank debt deal By Emelia Sithole-Matarise LONDON, Feb 8 (Reuters) - Spanish government bond yields dipped on Friday as some buyers bought the cheapened bonds after this week's sell-off but sentiment remained fragile on concerns over a corruption scandal. Spanish debt outperformed Italian paper, which has come under pressure as former Prime Minister Silvio Berlusconi's poll ratings have picked up ahead of elections in two weeks. Investors fear his potential comeback to the centre of the country's politics could derail its austerity programme. Shorter-dated Spanish bonds led Friday's rally, driving two-year yields 10 basis points lower to 2.72 percent. Traders cited domestic buying of the debt, which is likely to become the main target of a yet-to-be triggered European Central Bank bond purchase scheme. Spanish 10-year yields were down 6 bps at 5.35 percent , aided by healthy demand at the country's bond auction on Thursday. "There maybe some correction after the recent rewidening of spreads and it seems to be coming from the domestic front and maybe some follow-up buying after the strong auction yesterday," said Mathias van der Jeugt, a rate strategist at KBC. "We'll likely still see increased volatility and nervousness but I think neither the Italian elections nor the political scandal in Spain will bring back the level of stress we saw at the height of the crisis in 2011 or 2012." Spanish and Italian yields have tumbled from euro-era highs above 7 percent hit scaled last year after ECB President Mario Draghi vowed in July to do whatever it took to preserve the euro, backed in September by the new bond purchase plan. The rally has braked this month, however, with Spanish Prime Minister Mariano Rajoy under pressure to resign over a political scandal in which he denies wrongdoing, and Italian elections - including Berlusconi's potential return - rattling investors. "On the 10-year Spanish bonds, we could go significantly above 5.50 percent and reach the 5.60 area and it can be quite fast, and on the (Italian) BTP 4.70-75 area could be reached as well," BNP Paribas strategist Patrick Jacq said. "On a longer-term view we still expect market friendly outcomes of the political issues and the setbacks offer some opportunities to enter long positions." IRISH GLOW Both Italy and Spain were seen lagging lower-rated Irish bonds, whose rally was given fresh impetus on Thursday after Dublin clinched a bank debt deal that will cut the country's borrowing costs over the next decade. The benchmark Irish 10-year yield fell 6 bps on Friday, to 3.93 percent, its lowest level since before the start of the subprime crisis in 2007. "Obviously Ireland is trading through Italy and it can have further legs. Such a trade will even benefit from Ireland being flat and Italy getting some issues with the elections," Commerzbank strategist David Schnautz said. At the top-end of the euro zone credit spectrum, German Bunds also rose on Friday after comments from ECB chief Draghi fuelled speculation the bank may be willing to cut interest rates if the euro continues to strengthen. The Bund future was last 15 ticks up on the day at 142.97 with German 10-year bond yields at 1.50 percent , down 1 basis point. German yields, led by two-year paper, extended this week's falls after Draghi said on Thursday the ECB would monitor the economic impact of a strengthening euro, feeding expectations the surging currency will open the door to an interest rate cut. He also played down a rise in money market rates.