* Italy buys back 4 billion euros of five different bonds
* Buy-back underscored periphery's strong funding position
* Italian, Spanish yields fall 8-9 bps; Bunds flat
By Marius Zaharia and Ana Nicolaci da Costa
LONDON, Dec 10 Italian and Spanish debt premia hit their lowest since mid-2011 on Tuesday as Rome bought back 4 billion euros of bonds in another move highlighting the improved funding position for the euro zone's weaker states.
The two countries, which were at the forefront of the euro zone debt crisis two years ago, have already hit their 2013 funding targets even though each still has one bond auction scheduled before the end of the year.
Italy's buy-back follows a swap of 2015 and 2017 bonds for 2018 paper last month and the cancellation for December of a regular auction. The country has met its funding target for the year, helped by a sale of inflation-linked bonds aimed at retail investors that raised more than expected last month.
"There's been an increase in investor interest in those weaker credits in the euro zone as they see an opportunity of still interesting (yield levels) ... and the supply side looks encouraging as well," DZ Bank strategist Christian Lenk said.
The Italian Treasury bought back floating rate notes (CCTs) maturing in Dec. 2014 and Sept. 2015, fixed rate bonds (BTPs) maturing in March 2015 and April 2015 and bonds linked to euro zone inflation (BTPEIs) maturing in Sept. 2017.
Italian 10-year yields fell 8 basis points on the day to 4.07 percent, 224 bps more than benchmark Bund yields . Equivalent Spanish yields dropped 9 bps to 4.04 percent.
The two countries' borrowing costs have almost halved this year as investors piled into their high-yielding debt, lured by signs of economic stabilisation as well as the European Central Bank's crisis backstops and ultra-easy monetary policy.
But some analysts say 10-year yields will struggle to sustainably break the 4 percent level heading into the year-end auction and with the Federal Reserve expected to begin scaling back monetary stimulus early next year.
"Heading into the final weeks of the year, we don't think it's prudent to be invested in both that type of duration instrument and in that type of credit," said David Schnautz, interest rate strategist at Commerzbank.
A majority of economists in a Reuters poll on Monday still expect the Fed to start trimming its bond buying in March, but some were warming up to the idea that it could happen earlier.
German debt, which often moves in tandem with U.S. Treasuries due to their low risk profile, was expected to remain in recent ranges until the Fed's Dec. 17-18 meeting. Bund futures rose 8 ticks to a settlement close of 140.17.
Traders said low volumes distorted price moves as they tried to explain Spain's slight outperformance over Italy despite the fact that Italy was the country buying back debt.
Some analysts said this reflected the fact that investors are more sanguine about Spain's outlook.
"In Spain, the (political) situation is much more stable and the signs that the economic recovery is gaining pace are much more clear ... than in Italy," said Elwin de Groot, senior market economist at Rabobank in Utrecht.
Data on Tuesday showed Italy's economy stagnated in the third quarter after two years of contraction. Spain's economy returned to growth in the same period.
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