* German 2-yr yield near 10-month highs as ECB repayments loom
* Bunds weaker after solid Spain, Italy auctions
* Concern over U.S. debt ceiling talks to limit sell-off
By Emelia Sithole-Matarise
LONDON, Jan 18 German two-year bond yields rose near their highest in nearly 10 months on Friday on growing jitters in money markets over early bank repayments of three-year European Central Bank loans.
The shorter-dated German bonds underperformed longer-dated maturities, adding to the weaker tone in the euro zone's lowest-risk bonds exacerbated by strong auctions this week from Spain and Italy, as well as upbeat U.S. data.
Two-year yields extended a climb started on Thursday, when short-term money market rates rose to their highest level since July as anticipation built ahead of the repayment of loans from the ECB's long term refinancing operation (LTRO).
Banks can start making repayments from the end of January. Suggestions they may also have to provide more detail on the collateral they exchange for cash at the ECB, which could ultimately restrict banks' usage of the cheap loans, added to the jitters.
Some traders said the sell-off looked overdone given that the ECB was still expected to cut interest rates some time in coming months.
"The (German) front-end is being hit by the LTRO story. My view is it's oversold but there's something else at play there so it's very difficult to trade against it," a trader said.
German two-year yields rose to 0.25 percent, near peaks hit in late March 2012 and climbing further from negative territory they traded in late last year. Some traders saw scope for a rebound as some buyers still keen to hold German debt are lured back by the higher yields.
"We've hit some interesting levels. Schatz above 20 basis points haven't been there since early-to-mid last year," another trader said. "We don't have an ECB rate cut in the imminent future but a rate cut is more likely than a rate hike which is why I believe the front-end is oversold."
U.S. DEBT TALKS EYED
Bund futures were last 12 ticks down at 142.64, extending this week's falls after Spain capped a week of good auctions for peripheral euro zone issuers on Thursday, marking a successful start to Madrid and Rome's 2013 fundraising efforts.
Cash 10-year yields were slightly up at 1.55 percent, while upbeat Chinese data following better-than-forecast U.S. housing and jobless claims reports on Thursday kept safe-haven Bunds on the back foot.
"A number of people still have these long positions in Bunds. With the easing of risks in the euro zone, there's still so much cash in safe havens which might still go into higher yielding assets," said Piet Lammens, a strategist at KBC.
Some market participants, however, saw the sell-off in Bunds petering out going into the weekend on lingering concerns about talks to raise the U.S. debt limit as Washington's self-imposed end-February deadline looms.
"In the near-term we would like to remind ourselves of plenty of headwinds in both the U.S. and Europe - debt ceiling debate, Italian elections - that can dampen the current enthusiasm," Lloyds strategists said in a note.
"We thus look for a short-term retracement in core yields, providing better opportunities in the future to establish short duration positions."