May 27, 2013 / 2:20 PM / 4 years ago

EURO GOVT-Spain, Italy debt rallies as markets stabilise

* ECB seen keeping monetary policy accommodative

* Italy could underperform before debt sales later this week

* German Bunds dip as Dutch, Belgian supply eyed

By Emelia Sithole-Matarise

LONDON, May 27 (Reuters) - Italian and Spanish bond prices rose on Monday as riskier assets recovered from a sell-off and a European Central Bank policymaker signalled the bank would keep monetary policy ultra-easy.

Peripheral euro zone bonds were caught up in a sharp drop that hit equity markets last week on concerns that the U.S. Federal Reserve could start scaling back its stimulus programme in coming months if the economy continued to improve.

The policy outlook in the euro zone, however, is expected to remain accommodative to support the region's weaker economies. ECB board member Joerg Asmussen said on Monday the bank would stick to its expansive monetary policy as long as was necessary.

With U.S. and UK markets shut for holidays, European and Japanese markets were calmer and investors moved back into higher-yielding debt.

Italian 10-year yields were last down 10 basis points at 4.08 percent, having climbed near a 1-1/2-week high of 4.18 on Friday, while equivalent Spanish yields were 9 bps lower at 4.35 percent.

"The periphery got beaten up quite a bit last week so we're seeing a bit of a recovery but volumes are very thin with the U.S. and UK on holiday," one trader said.

"Everything is being driven by what's happening in Japan and in the U.S. If volatility goes up again and we see disorderly movements in Japanese bonds and equities and strengthening views that the Fed is looking to taper QE (quantitative easing) we could see peripheral yields rise again very quickly."

European shares rebounded on Monday.

Italy will test bond investor demand following last week's market jitters with a sale of up to 3.5 billion euros in zero coupon and inflation-linked bonds on Tuesday and an estimated 6-7 billion euros of conventional medium- to long-term debt on Thursday. Italy will give details later on Monday what maturities it will offer at its month-end auction.

Analysts expect the sales to meet good demand with the ECB's yet-to-be-tested bond-buying backstop underpinning a hunt for higher returns than those offered by safe-haven German bonds.

Bund futures dipped, with traders also making way on their books for new 10-year bonds to be auctioned on Tuesday by top-rated Netherlands. But the losses were seen limited with analysts citing technical factors supporting the market.

The future was last 29 ticks down at 144.29 and German 10-year yields 2.4 bps up at 1.42 percent.

The Bund bounced off a key support level, at 144.26, which is the 38 percent retracement of its recent rally, said Mathias van der Jeugt, a strategist at KBC in Brussels.

"Today we think this level will most likely hold because of the low volumes," he said.

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