Italian yields hit lowest since Fed stirred stimulus sell-off
* Italian, Spanish yields dip to pre-Fed meeting levels
* Signals from central banks are the leading market driver
* Bunds weaker as top-rated Dutch, UK debt sales weigh
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, July 23 (Reuters) - Italian 10-year bond yields fell at one point on Tuesday to their lowest level since the Federal Reserve meeting that laid out plans to scale back monetary stimulus and sent investors on a hunt for safety.
Since that June 18-19 meeting, Fed Chairman Ben Bernanke has made clear the plans were not set in stone and the European Central Bank has taken the unprecedented step of saying interest rates will stay at record lows for an "extended period".
The guidance from both central banks has eased investor worries that global liquidity could shrink to levels that would cause significant harm to the euro zone's weaker states such as Italy, bolstering demand for riskier assets.
On Tuesday, Italian bonds outshone safe-haven German Bunds, which fell in price, pushing up yields, as traders made room on their books for new British and Dutch debt supply from The Netherlands and Britain.
Italian 10-year yields fell as much as 5 basis points to 4.29 percent, their lowest since June 19, before reversing to last trade flat on the day at 4.35 percent.
Spanish equivalents also hit a five-week low, at 4.54 percent, before trading 5 bps up on the day at 4.65 percent in a holiday-thinned market.
"Central banks have been providing some tranquilisers for the market that there won't be tightening of monetary policy any time soon," said Bayerische Landesbank strategist Marius Daheim.
The yields were still about 30-40 bps above levels in May before Bernanke hinted that the pace of Fed asset purchases could slow later this year. Analysts said yields were unlikely to revisit those levels.
"The bias is for lower yields, but one has to be careful though because the environment is different than it was a few months ago when investors expected abundant liquidity for a very prolonged period," UniCredit rate strategist Luca Cazzulani said. He saw the floor for Italian yields at around 4 percent.
CENTRAL BANK DOMINATION
Spanish and Italian yields have fallen roughly half a percentage point over the past month despite a corruption scandal putting pressure on Spanish Prime Minister Mariano Rajoy and worries over the fragility of Italy's ruling coalition.
The two debt markets also showed resilience to a political crisis in Portugal, which president Anibal Cavaco Silva cooled over the weekend by ruling out early elections.
This shows markets are currently driven more by moves by the world's major central banks, which have doubled or even trebled their balance sheets in the past six years, than by factors such as political risk or weak growth prospects, analysts said.
However, some warned that without signs of economic recovery, this may not last.
The Bank of Spain projected a 0.1 percent quarter on quarter economic contraction in April-to-June.
"The situation where (markets) are focusing only on what the central banks are doing may not be sustainable," ICAP strategist Philip Tyson said.
German Bund futures fell 38 ticks on the day to settle at 143.82.
Traders said sales of debt in Britain and the Netherlands weighed on Bunds in a thin market. Britain was selling 4 billion pounds of 2044 index-linked gilts via syndication, while the Dutch raised 1.8 billion euros of eight- and 29-year bonds.
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