EURO GOVT-Italian bonds steady as yield hunters return
* Italian bonds steady before elections
* Italy vote nerves seen keeping German Bunds well-bid
* Spanish yields slightly lower after short-term debt sale
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, Feb 19 (Reuters) - Italian government bonds held steady on Tuesday as concern that weekend elections in Italy could produce a weak government were offset by bids from investors seeking high yields.
The risk that an inconclusive result could hamper Italy's reform efforts has occasionally weighed on Italian debt in recent weeks, but price dips have generally been met with renewed buying interest.
Traders said buyers included not only domestic banks and risk-tolerant hedge funds but also so-called "real money" investors who tend to hold on to their assets longer-term, such as pension funds and insurers.
They feel more comfortable holding the euro zone's lower-rated debt assets due to the bloc's main safety net, the OMT, which is the European Central Bank's so far untested bond buying programme.
"There is concern that we won't get a strong government in Italy," one trader said. "People are wary of that, but on the other hand the OMT has made everybody complacent and people need yield."
Italian 10-year bond yields were last 1 basis point lower on the day at 4.40 percent - some 280 bps over benchmark German Bunds - having traded in a roughly 4.1-4.75 percent range since mid-January.
KBC strategist Piet Lammens said the 10-year yield premium that investors charge on Italian paper over Bunds could rise by another 20-30 basis points going into the elections. But higher yields would be a buying opportunity, he said.
"If the result is negative, part of it has already been discounted by the market so I don't think we will go back to the crisis levels. It may be an opportunity to pick up Italian bonds if there's a big correction after the election," Lammens said.
Italian bonds slightly underperformed Spanish peers after Madrid successfully sold 4 billion euros in short-term debt. Analysts say an auction of longer-dated bonds by Spain on Thursday could be more challenging before the Italian vote.
"There was a little bit of concession building ahead of (today's) auction but overall this was a fairly favourable result from the Spanish point of view," said Marius Daheim, chief strategist at Bayerische Landesbank. "Then again it's short-dated paper which is easier to take down. We'll probably get a better picture on demand on Thursday."
Spanish 10-year bond yields were last 4 bps down on the day at 5.22 percent.
Safe-haven Bunds were steady as well, as the focus on Italian elections meant that the selling pressure seen after the better-than expected German sentiment data was only brief.
Bund futures were 7 ticks higher at 142.83, while cash 10-year German yields were 0.6 basis point lower at 1.622 percent.
Concerns over the Italian vote were expected to offer support to a German Bund auction on Wednesday. Demand for low-risk assets is expected to remain firm in the near-term, but a significant fall in Bund yields was unlikely, analysts said.
"Nobody wants to make a significant call before Italian elections," said Chris Scicluna, head of economic research at Daiwa Capital Markets. "If we get a large majority after the elections, that could lead yields in Germany to rise quite significantly ... 1.80 percent for the 10-year seems feasible."
"In the other scenario, which is more likely - a coalition that risks having a limited term, we wouldn't expect significant movement."
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