* Last-minute U.S. budget deal hurts Bunds, U.S. Treasuries
* Italian 10-yr yields at lowest in just over two years
* German two-year debt sale covered but demand slips
* Focus to turn to U.S. debt ceiling talks in coming weeks
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, Jan 2 (Reuters) - German Bund yields spiked and those on riskier euro zone bonds plunged on Wednesday after U.S. lawmakers approved a deal preventing a fiscal crunch that could have pushed the world’s largest economy into recession.
The Republican-controlled House of Representatives approved late on Tuesday a bill that will raise taxes on top U.S. earners, avoiding $600 billion in broad-based automatic tax hikes and spending cuts.
The last-minute deal, which fulfills President Barack Obama’s re-election pledge, spurred a rally in riskier assets such as equities and peripheral euro zone debt, and the perceived safest assets, such as Bunds and U.S. Treasuries.
Bund futures were last 160 ticks lower on the day at 144.04, while German 10-year cash yields were 13.5 basis points higher at 1.433 percent.
“Markets are celebrating the events in the U.S.,” said Niels From, chief analyst at Nordea. “But I don’t think it (the sell-off in Bunds) will go very far. As soon as we see Bunds getting cheaper buyers come back to the market.”
Concerns over the global economy and the euro zone debt crisis would ensure some of the vast sums of cash made available by central banks would find its way into safe-haven assets, he said.
Highlighting the underlying demand for German debt, a nudge into positive territory for yields on two-year bonds -- seen as among the safest investment instruments in the world -- was enough to ensure Germany could sell 4.15 billion euros of the debt in the euro zone’s first auction of the year.
Demand was weaker than at previous auctions, but the sale was comfortably covered.
“It was not the best day to auction German bonds but the result was not that poor,” said Patrick Jacq, a rate strategist at BNP Paribas.
The selling pressure in Bund markets could soon fade as focus turns to fresh talks on raising the U.S. debt ceiling to allow the government to continue borrowing, analysts said.
“This will be another debate for the next few weeks, which could possibly be supportive for Bunds,” Commerzbank rate strategist Rainer Guntermann said.
Nordea’s From said a clear break above 1.46 percent in 10-year yields, a level reached on several occasions since early November, would be “difficult” to achieve in the absence of further positive developments on the debt crisis and global economy.
Higher-yielding euro zone debt rallied on Wednesday, with Italian 10-year yields falling 23 basis points to 4.273 percent, their lowest in more than two years. Equivalent Spanish yields dropped 22 bps to 5.05 percent.
Debt issued by the two countries has rallied for several months on the back of a new European Central Bank bond buying programme that could be activated later this year.
However, many analysts caution the rally may have gone too far and markets may use the February elections in Italy as an opportunity to re-assess their stance on peripheral debt.
“The crisis is not over in southern Europe,” From said.