EURO GOVT-Italian bonds firm as auction goes smoothly
* Italy sells bonds at higher yields, demand stays strong * Some analysts recommend buying on dips before Italy vote * Demand firms at German two-year bond auction By Emelia Sithole-Matarise and Marius Zaharia LONDON, Feb 13 (Reuters) - Italian yields fell on Wednesday after Rome sold its first 30-year bond in nearly two years, with buying interest from yield-hungry investors offsetting pressure from those concerned about the country's political stability. Other peripheral euro zone bonds rose in tandem with Italy, as last week's increase in yields on concern about potential political instability in Italy and Spain, attracted some bargain-hunters. The swings in Italian debt prices seen this month are likely to continue at least until the Feb. 24-25 polls, analysts said. Demand held firm as Italy sold about 6.6 billion euros worth of debt of various maturities, including the first 30-year tap since May 2011, though borrowing costs rose compared previous sales. Italian debt has been under selling pressure recently as a comeback in polls by former prime minister Silvio Berlusconi's party raised the prospect of a fragmented parliament that could slow the reforms. Final polls before a blackout showed Berlusconi's centre-left opponents still on course to win, although they are likely to have to form a coalition with outgoing premier Mario Monti. Ten-year Italian yields were 12 basis points lower on the day at 4.39 percent -- some 40 bps below February highs, but about 30 bps above January lows. "There seems to be a return in (positive) sentiment towards the peripherals and, on the back of a realisation that political risk is probably being overplayed, we're seeing some asset allocators returning to that market," one trader said, adding volumes in Italian bonds were "quite respectable". Spanish 10-year yields fell 14 bps to 5.26 percent, with traders also citing bargain hunters. Spanish debt slightly outperformed Italian paper as it does not face supply pressure this week. Despite renewed buying interest, traders said selling pressure on pre-election nervousness could return in the next few days. "People feel a little more comfortable going back into the market now that the headline risk has diminished with the poll blackout before the elections," said Orlando Green, a rate strategist at Credit Agricole. "But as we get closer to the election there may be a bit more nerves that could be reflected in the periphery and the pressure will be on Italian spreads." DZ Bank strategist Christian Lenk said he still saw Italian bonds among euro zone outperformers in the medium term as he did not expect Italy to "completely reverse" its economic reforms. "We accept the fact that we will see volatility ahead of the elections. But we think they offer a decent yield pick-up especially as many other houses have turned more cautious." GERMAN DEBT The improved sentiment on the periphery weighed on German debt. Bund futures shed 50 ticks to settle at 142.05. German 10-year yields rose 3 bps to 1.67 percent with some traders saying selling pressure in the UK gilts market after the Bank of England cast doubt on further bond purchases was also spilling over into Bunds. Nevertheless, Germany sold 5 billion euros of new two-year bonds, carrying a 0.25 percent coupon. The previous two Schatz benchmarks had a zero percent coupon. Demand was better than at the previous auction in early January as yields rose by 20 bps. Two-year German yields ended 2012 in negative territory due to fears that potential large-scale automatic spending cuts, since avoided or at least deferred, in the United States could have sent the global economy into recession. Slightly better-than-expected economic data and growing confidence in the euro zone banking system as lenders repay crisis loans to the European Central Bank have also led to rising money market rates and higher short-term German yields.