* Italy far ahead in its 2013 funding programme
* Has enough leeway to adjust debt issuance strategy
* Political crisis a high risk, but investors not panicking
By William James and Marius Zaharia
LONDON, Feb 28 (Reuters) - Italy was quick off the blocks to raise funding this year, which means it can afford to ease off the pace or fall back on less risky short-term bond sales if Rome's political crisis makes investors reluctant to buy its debt.
Elections this week produced a hung parliament, raising concerns that prolonged deadlock could jeopardise efforts to reform the economy, a big concern for the investors that Italy relies upon to service its 2 trillion euros ($2.6 trillion) of debt.
But because it is far ahead of where it was a year ago in the annual race to meet its funding targets, Rome looks insulated from the acute concerns that threatened to freeze it out of financial markets in 2011 and again last year.
"The start to 2013 funding was a very good one. They have created some leeway to fine tune their issuance over potentially more tricky weeks going forward," said David Schnautz, interest rate strategist at Commerzbank in New York.
"I don't think they are getting into any big trouble here."
Italy has so far issued 36 billion euros of regular BTP bonds this year, and 28 percent of its total annual plan, with an average maturity of 7.3 years, according to Reuters data. By this time last year it had completed 18 percent of its goal and the average maturity of the 34 billion euros of nominal bonds it sold was 5.4 years.
If political uncertainty persists, borrowing costs for riskier long-term maturities would be the first to rise. In such a scenario the Italian Treasury would be more inclined to sell shorter-dated debt, analysts say.
An over-reliance on short-term bonds creates the problem of having to find ever-larger repayments and doesn't go down well with investors and rating agencies. But Italy has bought itself some wiggle room by issuing more longer-term debt this year, including its first sale of 30-year debt since May 2011.
Another option available to Milan is temporarily to cut the size of its auctions to address any fall in demand, though auctions since the election have gone relatively smoothly.
"If there is a perception that you need to safeguard the cost of funding, that would be done by reducing sizes a little bit," said Luca Cazzulani, deputy head of fixed income strategy at UniCredit.
"After all, you've done one fourth of the programme in one sixth of the time, so you are already advanced and you can slow down a little bit if you need to."
Analysts say the longer it takes Italy to form a government, the further funding costs are likely to rise, but they do not think, for now, that it will return to unaffordable levels of 7 percent or more for 10-year debt.
Returns for many bond investors have been shrinking in recent years as they opted to keep their cash in low-yielding, top-rated German or U.S. debt.
But this year foreign investors have returned to Italy, confident that if the crisis escalates again, the safety net provided by the European Central Bank's so far untested bond buying programme (OMT) would be there to catch them.
In a sign that their appetite for risky assets may hold firm at least in the near term, a bond auction on Wednesday saw better levels of demand than previous sales.
Although yields rose by about 50 basis points, 10-year borrowing costs held below 5 percent, far off last year's highs of 6.7 percent or 2011's euro-era highs of close to 8 percent.
"There was a great big sigh of relief when the Italian bond auctions went through smoothly ... Although yields were higher, they weren't at really elevated levels," RIA Capital Markets bond strategist Nick Stamenkovic said.
Nevertheless, analysts say Italy cannot afford to slow down issuance too much, or retreat too deeply into the shelter of short-term paper.
The country still has to sell 13 billion euros of bonds a month this year to meet its funding target, meaning that prolonged political uncertainty could eventually wipe out the advantage Italy has built up.
If yields start to rise across maturities and foreign investors abandon their positions in Italy, markets will still end up looking for the ECB to step in and buy bonds to shore up the country's finances.
"We are far off the worst market picture we have seen in Italy ... However, if the political picture deteriorates further, this could have important consequences," RBC Capital Markets rate strategist Norbert Aul said.