Italian bonds ride out political uncertainty before auction
* Italy to sell up to 6.5 bln euro of five- and 10-year bonds
* Court to rule on former PM Berlusconi's tax fraud case
* Ruling may have impact on government stability
By Marius Zaharia
LONDON, July 30 (Reuters) - Italian government bonds were a tad stronger on Tuesday, as investors expected a bond auction to go smoothly despite renewed political uncertainty caused by former Prime Minister Silvio Berlusconi's tax fraud case.
Italy's highest court convenes on Tuesday to rule whether former Prime Minister Silvio Berlusconi should be jailed and banned from public office, a verdict that could endanger the country's shaky coalition government.
Some members of his centre-right PDL party, which is in a coalition with premier Enrico Letta's centre-left PD, have called for a mass resignation of PDL ministers if the court, which may take up to three days to decide, rules against him.
Despite the political tensions, the auction of up to 6.75 billion euro ($9 billion) of bonds maturing in 2018 and 2024 was expected to find comfortable demand, helped by Monday's cheapening of the bonds and large redemption flows.
Some 10 billion euros of Italian bills are due to be repaid on Wednesday, while 25 billion euros of bonds mature on Thursday. Italy and Spain pay a combined 16.6 billion euros worth of coupons this week, according to Reuters data.
"Redemptions and coupons are much larger than this week's periphery supply, so we are expecting auctions to function well despite the general lack of liquidity in secondary markets," Credit Agricole rate strategist Peter Chatwell said in a note.
Italian 10-year bond yields were 2 basis points lower on the day at 4.44 percent, in the middle of this year's roughly 3.7-5.1 percent range.
The upper end of the band was first tested when February's inconclusive elections kept Italy without a government for two months before the two big parties agreed to share power.
"You could say that when Italy didn't have a government earlier this year there was little or no market impact so why should it be different now?" said Rabobank rate strategist Lyn Graham-Taylor.
"It is different because (Federal Reserve) tapering is just around the corner ... so people will care more this time around. It could have a bigger impact in terms of an increase in Italian yields."
The Fed, the European Central Bank and the Bank of England will hold policy meetings this week. Graham-Taylor said the most important was the Fed meeting, with investors looking for clues to when its plan to reduce bond purchases could kick off.
Traders said euro zone government bonds, and especially benchmark German Bunds, are unlikely to move too much in either direction before the meetings.
That is even if data such as euro zone business and consumer sentiment or German inflation surprise later in the day.
"The risk is that we see a bit more strong data ... but even if we do we're going to be holding on until the Fed meeting tomorrow night," one trader said.
Bund futures were 4 ticks lower at 142.42.
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