* Dutch yields fall after 2 bln euro debt sale
* "Risk on" sentiment weighs on Bunds, for now
* Spain and Italy see borrowing costs rise
By Kirsten Donovan
LONDON, April 24 Yields on Dutch and peripheral euro zone government bonds eased on Tuesday as the Netherlands sold bonds without problems, calming markets a day after the government collapsed in a crisis over budget cuts.
The Netherlands raised 2 billion euros through the sale of two- and 25-year bonds, around the middle of the target range, a quite normal outcome at Dutch auctions. Borrowing costs rose but were broadly in line with market rates.
"The negative news doesn't extend further given that the auction is ... a solid one," said Michael Leister, rate strategist at DZ Bank in Frankfurt.
"It will be sufficient to keep the tightening momentum that we see in Dutch spreads across the curve going."
Dutch two-year bond yields were 14 basis points lower on the day at 0.38 percent, with 10-year yields 9 bps lower at 2.34 percent.
That reversed much of Monday's rise which drove the 10-year yield spread over German Bunds to its widest in three years on worries not only about a country previously seen as a solid investment, but also about eroding support for euro zone measures to contain the debt crisis.
"There's a bit of a relief rally after yesterday's blood bath," a trader said. "We're seeing some good flows in euro govvies, some buying interest in the new long Dutch paper with some switching out of German 30-year paper ahead of tomorrow's sale there."
Germany set a record low 2.5 percent coupon on a new 30-year bond of which it aims to sell three billion euros on Wednesday.
But the auctions are unlikely to calm nerves for long with the debt crisis intensifying and borrowing costs rising.
Spain, which has taken centre stage on concerns about its ability to meet budget targets as well as the health of its banks, sold three- and six-month treasury bills but saw borrowing costs almost double.
Italian borrowing costs also rose at an auction of zero-coupon and inflation linked paper and its bonds underperformed their Spanish counterparts before Italy sells medium- and long-term debt on Friday.
"Markets are going to fluctuate over the next 3-6 months but it's hard to believe there's going to be any real joined up political will or any economic data which suggests we're near the end of the crisis," said Gary Jenkins, director of Swordfish Research.
"That means Spanish and Italian yields will continue to rise and Bunds most likely stay close to where they are."
Spanish 10-year bond yields fell 9.5 bps to 5.93 percent - failing to sustain a rise above the crucial 6 percent level - while the Italian equivalent fell 3 bps to 5.72 percent.
Safe-haven German Bunds eased after rallying sharply on Monday but a further fall in yields is likely given the growing pressure on the euro zone periphery and the potential for the pool of liquid triple-A rated debt to shrink if the Dutch political crisis drags on.
June Bund futures were 29 ticks lower at 141.00 after hitting record highs of 141.37 on Monday.
"The crisis is coming from all angles," a second trader said. "At these levels in Bunds you have to think a lot of the short positions of a couple of weeks ago have been covered but we can still go higher. It's hard to know what can stop it when even the firepower of the (euro zone) rescue fund doesn't look big enough."
Ten-year German yields rose 3 bps to 1.587 percent, not far from Monday's all-time low of 1.549 percent.
Traders said market players were scaling back the size of their trades, or risk positions, as market volatility increased.
"In a volatile situation, you don't need a big bet on to find you've got it horribly wrong," said another trader.
"Risk positions get pared back and that exacerbates the situation more. Everyone comes in the morning with a flat book and the first three trades will set the tone for the day."