* Italy leads periphery higher after Greek austerity passed
* Greek debt swap deal still to be sealed
* German bond yields rise, but 10-year capped at 2 percent
By Emelia Sithole-Matarise
LONDON, Feb 13 (Reuters) - Italian bonds led lower-rated euro zone debt prices higher on Monday after Greece approved austerity measures that took it closer to securing a new bailout, but remaining hurdles were seen likely to restrict any sharper sell-off in safe-haven debt.
Market sentiment has yo-yoed in recent weeks as Greek political parties struggled to agree on the unpopular reforms demanded by the International Monetary Fund and the European Union in exchange for a second bailout worth 130 billion euros.
Euro zone finance ministers meet to sign off on the rescue package on Wednesday, which will enable Athens to avert a default for now. But they will expect Greece to explain how 325 million euros of this year’s budget cuts, as yet unspecified, will be achieved before approving the bailout.
Niggling investor doubts about Greece’s ability to implement the reforms which have sparked violent protests in Athens, and debt auctions this week from Italy and Spain, also meant the rally in peripheral bonds was likely to be modest.
“The risk aversion move should largely reverse ... but there are still some remaining risks. They (EU finance ministers) need to see the firm commitment and the (budget) cuts need to be plausible,” said Rainer Guntermann, a strategist at Commerzbank.
“The market is a little bit more cautious and the remaining uncertainty will limit the downside for Bunds.”
Italian 10-year yields fell 11 basis points on the day to 5.53 percent, taking their decline so far this year to more than 150 bps and closing in on equivalent Spanish yields which were last at 5.26 percent.
JPMorgan strategists see opportunities from the relative underperformance of Spanish debt against Ialian peers, recommending “overweighting Spain cross market, versus Italy or Belgium, favouring post-seven-year maturities”.
Portuguese yields also fell across the curve but the shorter-dated rates remained higher than 10-year maturities on persistent worries that Lisbon will also seek a second bailout.
The rebound in peripheral bonds could be shortlived as traders push for cheaper prices to make way for 25 billion euros of euro zone debt supply this week, with Spain and Italy looking to sell medium-term bonds.
“Italy and Spain are very much in the market focus and the supply is all coming in the medium-term part of the curve so this will be a very crowded place this week as the Netherlands and France will issue similar maturities,” Guntermann said.
“This could limit a bit the rebound in the medium part of the peripheral curves and we might see a little bit more price concession before the auctions.”
Before Italy’s sale of 6 billion euros of bonds on Tuesday, the country saw short-term borrowing costs fall further at a sale of 12 billion euros of treasury bills on Monday. But demand weakened, possibly due to a technical glitch, raising questions about the sustainability of the liquidity-fueled rally.
“As yields find a floor after several weeks of sharp declines, more attention will be paid to Italy’s economic fundamentals which are deteriorating markedly,” said Nicholas Spiro, managing director at Spiro Sovereign Strategy.
”Right now, the market is unsure about the fair value of Italian sovereign risk.
German 10-year yields rose 4.5 bps to 1.972 percent while the March Bund future dropped 43 ticks to 137.80.
German 10-year yields have struggled to break conclusively above 2 percent as Greece’s string of broken promises and protracted negotiations with its creditors sustained demand for safe-haven bonds.
“I expect any knee-jerk selling of Bunds to find good buying over the next day or two, especially if the yield is above 2 percent on the 10-year,” Peter Chatwell, a strategist at Credit Agricole, said.
“We have all been reminded of just how reluctant Greece is to do the right thing in the long term, so although the default risks for March may be much lower that is not to say market scepticism doesn’t manifest itself elsewhere.”