Italian, Spanish bonds hit by capital provisioning report
* Italian and Spanish bonds come under selling pressure
* Slovenian debt rallies after banks stress test
* Upbeat U.S. retail sales data hurts German Bunds (Updates to throughout)
By Ana Nicolaci da Costa and Emelia Sithole-Matarise
LONDON, Dec 12 (Reuters) - Italian and Spanish bonds fell on Thursday after a media report that the ECB could make euro zone banks hold capital against sovereign bonds to stop weak lenders using its cash to buy debt from crisis-hit countries.
The Financial Times quoted European Central Bank executive board member Peter Praet as saying the bank could toughen up requirements on sovereign bonds - which have traditionally been treated as risk-free.
ECB President Mario Draghi said the bank would not unilaterally assign risk weightings to the various government bonds on banks' balance sheets, indicating this would not happen in the short term.
Even so, investors sold bonds issued by Spain and Italy, where domestic banks used long-term ECB funding to buy and underpin their debt markets.
"The risk is that domestic banks can no longer support government bonds as they have done in the last two years but I don't think the ECB will take the risk of having a spike in yields and spreads ... They will probably change the rules but gradually," said ING strategist Alessandro Giansanti.
Spanish 10-year yields rose 6 basis points to 4.10 percent while Italian equivalents were 5 bps higher at 4.10 percent. Their two-year yields were up 7 and 4 basis points respectively.
A trader said if the ECB decided to introduce such rules it was not a big reason to sell, but some investors had decided to book profits after the report.
ECB officials have floated the idea of a fresh dose of cheap long-term loans to revive credit activity but are wary that banks could end up using the cash to buy government bonds, as happened with the more than 1 trillion euros of three-year loans they got in late 2011 and early 2012.
Domestic investors have increased their ownership of Spanish and Italian bonds in recent years as they sought to plug holes in demand left by foreigners during the debt crisis and keep a lid on borrowing costs for Rome and Madrid.
Foreign buyers held about 30 percent of Italy's 1.7 trillion euro debt securities as of end-June, Bank of Italy data show. Foreigners held around 36 percent of Spain's 674 bln euro debt in September, according to Bank of Spain data.
The weakness in Italian and Spanish bonds contrasted sharply with moves in the tiny Slovenian market, where the results of bank stress tests resulted in a bond rally.
Slovenian 10-year yields fell to their lowest level in nearly nine months after the central bank said the country's ailing banks needed 4.8 billion euros in extra capital to stay afloat, which the government said it could afford without an international bailout.
"Today's results are very positive for the credit in our view and should leave fiscal reserves in even better shape than we had anticipated," RBS said in a research note. "We stick with our long Slovenia recommendation."
Slovenian 10-year yields slumped as far as 5.34 percent, the lowest since March, according to Reuters data.
U.S. retail sales rose solidly in November - the latest in a series of upbeat releases that have fueled speculation the Federal Reserve could curb monetary stimulus soon, perhaps even at its rate policy meeting on Dec. 17-18.
Some in the market brought forward bets on Fed tapering after above-forecast U.S. jobs data last week, while a U.S. budget deal - which the U.S. House of Representatives could vote on on Friday - would remove another obstacle. The consensus in a Reuters poll remains for a March move
"It's just another (piece of) information that increases the probability of that happening in December, on top of what we saw last week as well," said Alessandro Tentori, global head of rates strategy at Citi.
German Bunds settled 20 ticks lower at 140.10. (Editing by Catherine Evans, John Stonestreet and Sonya Hepinstall)
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