* Italy sells three-year debt at lowest yield since Jan
* Talk of Spanish syndicated deal persists
* Bunds edge up but hold near six-week lows
By Marius Zaharia
LONDON, May 13 Italian bond yields edged up on Monday, even after a strong debt auction, as expectations of more supply from the euro zone's lower-rated states put another dent in this year's strong rally.
Italy sold 8 billion euros of three- and 13-year bonds, with borrowing costs for the short-dated paper at their lowest since January and demand levels holding firm.
Benchmark 10-year yields in secondary markets, however, continued to rise, last trading 7 basis points higher on the day at 3.97 percent versus 3.95 percent before the sale.
"The auction went pretty smoothly, it got decent demand, yields are lower, but it was not enough to turn around the correction in peripheral bonds," RIA Capital Markets bond strategist Nick Stamenkovic said.
"This is a healthy correction, it is not a change in the underlying trend."
He said 10-year yields above 4 percent in Italy and 4.40- 4.50 percent in Spain would probably lure investors back in.
Traders said the profit-taking moves which have pushed Italian and Spanish 10-year yields about 20 basis points higher in the past week have been triggered mainly by speculation that Spain may launch a syndicated debt sale in the near future.
The Spanish government has not commented, but market talk persists after strong syndicated debt sales by Portugal and Slovenia earlier this month.
"It might put some pressure on Spanish bonds in the near term if rumours persist but I don't think it would be a reason to delay it or not to do it," said Mathias van der Jeugt, rate strategist at KBC in Brussels.
Appetite for lower-rated euro zone debt has been strong this year as ultra-easy central bank policies have pushed investors towards riskier assets in search of higher returns.
Spanish 10-year yields were 7 bps higher at 4.28 percent
At the other end of the credit spectrum, German Bund futures were 28 ticks higher on the day at 144.94, after matching Friday's six-week low at 144.43 at the open.
Comments by ECB governing council member Ignazio Visco that the central bank could cut the deposit rate into negative territory eased expectations that a run of better economic data could put the ECB off further easing.