* Italy to sell up to 5.5 billion euros of bonds
* Domestic demand seen weakening as ECB review eyed
By Emelia Sithole-Matarise
LONDON, Dec 30 (Reuters) - Italian yields rose on Monday ahead of a 5.5-billion-euro debt sale that could be undermined by weakening domestic demand before a review of banking assets that will look at the risks of lenders' sovereign exposure.
Rome plans to sell up to 3 billion euros in five-year debt and up to 2.5 billion euros in 10-year bonds in its last auction this year. A short-term debt sale last Friday saw yields rise on waning demand in illiquid markets.
Italian bonds have been under selling pressure in recent sessions on speculation that domestic banks may reduce their large holdings ahead of a European Central Bank health check.
The ECB will use balance sheets as of Dec. 31 in its review of bank assets, including government bonds, next year.
"The auction will probably go OK but will see limited demand given it's the end of the year. A lot of what we are seeing (in the bond market) is related to the turn of the year and the asset quality review but what's key is how things will look next Monday after the new year," said Anders Svendsen, chief analyst at Nordea in Copenhagen.
Italian 10-year yields were last 3 basis points up at 4.24 percent, while Spanish equivalents were 2 bps higher at 4.25 percent.
In core markets, German 10-year yields were slightly up at 1.95 percent, near their highest levels since mid-September as an upbeat U.S. outlook soured investor appetite for safe-haven bonds. Bund futures were last 6 ticks lower at 138.96 in holiday-thinned trade.
"We are seeing some optimism on the world economy and that's bond negative... The ECB might do more (on loosening monetary policy) if we start to see yields rising more significantly but we're probably looking at the coming quarter with them on hold," a trader said.