* Risk appetite recovers, Bunds dip, but tension remain high
* Bunds underpinned by uncertainty over Cyprus bailout
* Spain, Italy rebound as some keep faith in ECB backstop
By William James
LONDON, March 20 Fresh uncertainty over Cyprus's future in the euro zone kept German Bund yields near their lowest levels of the year on Wednesday after the country's parliament rejected a bailout plan that involved a bank levy.
While German Bund futures, sought as a safe haven in times of market stress, were 20 ticks lower on the day at 144.42, they remained at elevated levels and few expected prices to fall much further in the near term.
A 36-0 parliamentary vote against plans to partially fund a bailout for Cyprus with a deposit levy left policymakers scrambling to find another solution, keeping investors in cautious mood.
"Their options are pretty limited. Either they reach some compromise on a deposit levy and/or they get some help from Russia," said Nick Stamenkovic, strategist at RIA Capital Markets in Edinburgh.
Cypriot Finance Minister Michael Sarris was in Moscow for talks with Russian officials about a 5 billion euro loan and an easing of the terms on existing arrangements.
"Clearly it's a very murky situation, so that should keep core government bonds underpinned for the near term," Stamenkovic said.
Ten-year German bond yields were 1 basis point higher on the day at 1.36 percent, but still 9 bps lower on the week and within sight of Tuesday's 2013 low of 1.34 percent.
The precarious position of Cyprus's banks, which are heavily dependent on European Central Bank support, has led policymakers to urge rapid progress on a new solution. Without a solution, Cyprus risks default as early as June, when a 1.4 billion euro bond matures.
Cypriot banks stayed shut on Wednesday and party leaders were holding crisis talks to explore a way forward.
The chaos in Cyprus has already caused investors to back away from bonds issued by the region's other struggling countries, and recent upward pressure on Spanish and Italian bond yields was expected to resume.
"The risk is that we see more serious contagion... we're sticking to our long Bunds, short periphery positions," a trader said, referring to bets that the yield gap between German and weaker bonds would widen.
Despite the expectation of more pressure, a strong open on equity markets and expectations that European Central Bank safety measure would limit contagion helped keep Italian and Spanish yields in check.
The 10-year Italian yielded 4.67 percent, down 4 basis points on the day, while the Spanish equivalent yield was 2 bps down at 5.03 percent.
"On the long term I would say all the widening we have seen in Italy and Spain are opportunities to play for another spread compression," said BNP Paribas strategist Patrick Jacq.
"But, having said that, it's clear that the very near-term environment remains risky enough not to enter these kind of trades massively."
The short-term risks were expected to support a 4 billion euro sale of 10-year German debt due later in the session.