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* Slovenia's yields jump on political uncertainty
* Fitch upgrade of Spain drives Spanish yields lower
* Economic fundamentals of euro zone peripherals improving
By Emelia Sithole-Matarise
LONDON, April 28 Slovenian bond yields rose sharply on Monday after Prime Minister Alenka Bratusek lost the leadership of her ruling centre-left party, threatening the government's survival.
Bratusek lost the leadership of Positive Slovenia to Zoran Jankovic, the mayor of Ljubljana. But the party's three coalition partners have said they will not cooperate with Jankovic, who is under investigation for corruption.
Elsewhere in the market on Monday, Spanish 10-year yields slipped back towards 8-1/2-year lows after Fitch upgraded Spain's ratings against a backcloth of generally improved appetite for the debt of euro zone peripheral economies.
However, the fall of Slovenia's government and early elections would slow efforts to improve the economy of the tiny ex-Yugoslav republic, which has been showing tentative progress.
Slovenian bonds underperformed the euro zone market, with 10-year yields jumping 22 basis points to 3.91 percent in early trade.
"The market clearly doesn't like it when you have volatility in the government, especially for a country like Slovenia where there's a lot to do," said ING strategist Alessandro Giansanti.
"We expect in the short term the risk of having a political crisis will result in some widening in Slovenia spreads, especially for a country that has been performing well over recent months."
Like other peripheral countries, Slovenia has seen its borrowing costs fall sharply this year, with 10-year yields falling back to 2007 lows as investors regain confidence in the euro zone region as fears about its debt crisis ebb.
Slovenia only narrowly avoided needing an international bailout a few months ago, but its banks still face problems that could drag on if the political situation deteriorates.
"Whilst we do not see this as a credit blow-up event, we think the bonds should trade meaningfully wider, perhaps by as much as 50 basis points," RBS strategists said in a note.
"We now attach an 80 percent probability that the government breaks down and Slovenia is forced down the road of early elections," they said.
FITCH BOOSTS SPAIN
Fitch lifted Spain's outlook by one notch to BBB+ after the market close on Friday, three notches above sub-investment grade, saying the country's financing conditions had improved and the economic outlook was less certain.
On a day of scheduled credit reviews by the ratings companies, Fitch had earlier improved the outlook on Italy, which along with Spain were two years ago at the forefront of the region's debt crisis. S&P also raised its rating on bailed-out Cyprus, suggesting the recovery was spreading to the peripheral states left most exposed to the financial crisis.
Spanish 10-year yields fell 2 basis points to 3.07 percent, not far from an 8-1/2-year low of 3.04 percent hit last week. Equivalent Italian yields were a touch up at 3.12 percent but stayed within reach of a record low of 3.07 percent plumbed a week ago.
"It (the Fitch ugprade) is confirmation of what the market has already seen in the last few months reflected in the sharp rally in peripherals," said ING's Giansanti.
"Underlying fundamentals for the peripheral countries in general are improving, economic growth and fiscal policy are improving, so the market is more confident that the current governments of peripheral countries are more reliable than in the past in keeping public finances under control."
The European Central Bank's looser monetary policy has encouraged investors hunting for higher returns to bet on recovery in countries worst affected by the debt crisis.
The markets' focus this week will be on euro zone inflation data, which could determine whether the ECB takes measures as early as next week if inflation undershoots forecasts.
(Editing by Gareth Jones)