* German 10-yr yields spike to 3-month highs after strong U.S. data
* German 2-year yields rise back above U.S. counterparts
* ECB 3-yr loan repayments set to keep short-term yields up
* Focus on banks' takeup of ECB short-term loans
By Emelia Sithole-Matarise and William James
LONDON, Jan 28 German 10-year bond yields rose to their highest in over three months on Monday after a bigger-than-forecast rise in U.S. durable goods orders dented demand for low-risk debt.
The U.S. data, for December, triggered a renewed slide in Bund prices that started on Friday after European Central Bank figures showed banks planned to repay a bigger than expected 137 billion euros of three-year loans snapped up in late 2011.
This was taken as a sign that areas of the banking system were recovering and that money market rates would rise, driving German short-dated yields above their U.S. counterparts for the firs time in two years.
Signs of a more upbeat outlook on the world's biggest economy and the ECB loan repayments were likely to curb demand for safe-haven debt in coming weeks, keeping yields higher.
German 10-year yields rose 7 basis points on the day to 1.64 percent while two-year debt yielded 0.30 percent, up 5 bps on the day and rising back above U.S. peers.
"The numbers in the U.S., in general terms show some improvement...Germany also showed some improvement last Friday," said Alan McQuaid, chief economist at Merrion Stockbrokers.
"Put that together with the fact that the market is taking the level of repayment by the banks as a sign there is healing in that sector it's not a surprise we are seeing core bond yields rising."
German Bund futures fell 71 ticks on the day to settle at 141.79, with technical charts pointing to further weakness, with UBS analyst Richard Adcock saying the latest sell-off exposed the contract to the Oct. 18 low of 141.14, then 140.10, the Sept. 17 low.
Longer-term, the prospect of excess cash draining from the system could keep upward pressure on yields, with banks now having the opportunity to repay cash on a weekly basis.
In theory, the less surplus cash in the system, the more banks have to compete to secure funds, driving short-term rates higher, generating a knock-on effect into bond markets.
ING rate strategist Alessandro Giansanti said two-year yields could rise as high as 0.4 percent as market conditions normalise over the coming months.
Focus will now turn to weekly repayments to see if banks continue returning the cash and particularly on Feb. 27, which for the first time will include repayments from the second of two long-term borrowing operations held a year ago.
There as plenty in the market, however, who believe the risks remaining in the euro zone still warrant investment in safe haven assets.
"Bund yields can push higher but I don't see a dramatic rise as there are still plenty of issues that could throw a spanner into the works," McQuaid said. "Italian elections are coming up ...and that could potentially make markets more nervous again. The rest of the euro zone economy is also lagging."
Market focus is also on supply this week after Italy began a busy week by launching new zero coupon and inflation linked bonds worth a total of 6.63 billion euros which raised close to the treasury's maximum target and showed that appetite for higher-yielding bonds remained intact.
New inflation-linked bonds are typically issued using a syndicate of banks who underwrite the deal in advance - making sure the bonds are sold - but Italy opted to avoid the extra expense and use an auction.
"The auction was allocated without problem. The market's perception... in the linker sector was quite good. Issuing new linkers by regular auction is a strong signal," said Chiara Manenti, strategist at Intesa SanPaolo.
The auction augurs well for Wednesday's planned sales of five and 10-year bonds which could net the Treasury up to 6.5 billion euros and, based on Reuters data, take Italy's funding close to 18 percent of its full-year target within January.