(corrects auction date in first paragraph)
By Ana Nicolaci da Costa
LONDON Dec 23 Italian bonds fell on Monday after Italian consumer morale dropped more sharply than expected in December and as the country faces its last auction of the year this week.
They fell in line with the rest of the euro zone debt market, where price moves were being exaggerated by thin liquidity before the Christmas holidays and the end of year.
German yields were near their highest since mid-October after the Federal Reserve announced it would scale back asset-purchases last week and investors would turn to a personal consumption report to gauge the pace of stimulus withdrawal.
After the Italian and Spanish premium over 10-year German Bunds fell by more than 50 and 100 basis points respectively this year, investors were taking some profits as they balanced their books into the end of the year.
"In a thin market, the data might be enough to take bond prices lower," Lyn Graham-Taylor, fixed income strategist at Rabobank said.
Italy's consumer confidence index fell to 96.2 in December from a revised 98.2 in November and well below a median forecast of 98.8 in a Reuters survey.
Ten-year Italian bond yields were up 4.5 basis points at 4.17 percent pushing the premium over Bunds 2 basis points wider on the day to 228 bps.
The Spanish equivalent was 5.1 bps higher at 4.2 percent, pushing the yield gap with German Bunds 4 bps higher to 232 bps.
The Italian Treasury said on Friday it would offer 8 billion euros of Treasury bills and up to 3 billion euros of zero-coupon bonds at its regular end-month auction on Dec. 27.
It also said it would sell more retail bonds, known as BTP Italia, in 2014 due to the enormous success of this year's auctions.
German yields continued to be supported by an improving U.S. outlook. The International Monetary Fund predicts the U.S. economy would expand at a faster pace next year, given positive economic data and some signs of compromise in Congress, the head of the Washington-based lender said on Sunday.
The comments come after an upward revision to U.S. growth data on Friday underpinned the view that the Fed's decision to scale back its asset-buying programme was justified.
Against this backdrop, investors would look at a U.S. personal consumption data later, including a gauge of inflation, to assess the pace of stimulus withdrawal.
"You would expect to see some upward pressure on German yields if we were to continue to see surprises such as (the growth data) coming from the U.S.," Chris Clark, rates strategist at ICAP, said.
"The market is expecting a fairly robust personal income report. This would tie into the generally upbeat picture that we have been seeing in the U.S. recently."
German Bund futures fell 20 ticks to 139.72, pushing yields up 1.9 basis point to 1.89 percent.
They touched 1.903 percent earlier - not far from Friday's 1.906 percent, which was the highest since mid-October.
"We are at about 15-20 percent of normal volumes," one trader said.
On Friday, volumes totaled nearly 410,000 lots, well below this year's daily average of nearly 682,000 lots. One lot represents 100,000 contracts traded. (Editing by Toby Chopra)