EURO GOVT-Italian bonds volatile on uncertain vote outcome
* Phone polls show centre-left ahead of Berlusconi group
* Bunds fall as rest of periphery follow Italian rally
* Doubts on Monti's role could sour sentiment
By Emelia Sithole-Matarise
LONDON, Feb 25 (Reuters) - Italian bonds rose on Monday after initial projections showed the country's reform-minded centre-left coalition with a slim lead but fears of a hung parliament quickly reversed the gains.
Investors had been cheered by a poll for Sky television published after voting ended showed the coalition of Pier Luigi Bersani leading in both chambers of parliament, on 34.5 percent of the vote, with former Prime Minister Silvio Berlusconi's conservatives on 29 percent.
The anti-establishment movement of Beppe Grillo came third with 19 percent while outgoing technocrat Prime Minister Mario Monti's centrists came in fourth at 9.5 percent.
Italian 10-year yields fell to their lowest in three weeks around 4.17 percent, with other debt yields for the euro zone's troubled periphery sliding in their wake, before reversing course as subsequent projections showed the centre-right parties of Berlusconi - distrusted by markets - leading in the Senate.
"It might well be possible that we get a hung parliament with the Senate being led by the Berlusconi camp and Bersani in the lower house. This would be one of the most negative outcomes for the market," said Christian Lenk, a strategist at DZ Bank.
"It all depends on what the actual outcome of the vote is going to be. If we see a hung parliament, then the market would rather go risk off ... no-one really wanting to commit to buy periphery in the scenario where you don't know for weeks or maybe one or two months how the future in Italy is going to be."
Nervousness over the role of Monti in a future government after the polls showed him trailing was also tempering demand for higher-yielding euro zone debt, prompting low-risk German Bunds to cut earlier losses.
Italian 10-year yields were last two basis points down on the day at 4.43 percent, unwinding their outperformance against German benchmarks which had tightened their spread to a session low of 255 bps.
"There's nervousness that Monti may be left out of a governing coalition ... there's still a lot of uncertainty," said Peter Chatwell, a rate strategist at Credit Agricole.
Bund futures settled at 143.52, 10 ticks down on the day but well off a session low of 142.85 plumbed earlier, with German 10-year yields steady at 1.57 percent.
Under a less conclusive result, with no clear winner, Italian debt could underperform German bonds on the grounds that it would be hard to form a stable government committed to the economic reforms markets believe necessary.
Earlier, before voting ended, an auction of Italian inflation-linked and zero-coupon debt drew solid demand, while bond yields dipped and the country's stock index rose - moves consistent with the market's initial lack of investor concern at the expected outcome.
The focus will now be on a treasury bill auction on Tuesday when borrowing costs could rise given the uncertainty over the election result.