* Italy bonds weather Berlusconi ruling
* No immediate Italian political crisis seen
* Bunds reverse losses after U.S. payrolls data
By Marius Zaharia
LONDON, Aug 2 (Reuters) - Italian bonds outperformed their euro zone peers on Friday as investors saw limited risk of an imminent political crisis erupting over the conviction of former Prime Minister Silvio Berlusconi.
While upholding his jail term, judges ordered a Milan court to review a five-year ban on Berlusconi from public office, enabling him to remain a senator and leader of his centre-right People of Freedom Party for the moment.
The market moves underlined the strength of the Italian market, where a diverse domestic investor base holds about two thirds of total debt, while foreign investors find comfort in the European Central Bank’s conditional promise to buy bonds if necessary to avert crisis.
“We believe this (Berlusconi) situation is a distracting side show and will not materially affect government debt,” said Peter Wilson, senior portfolio manager at Wells Fargo Asset Management, a firm with $450 billion under management.
“While more real work needs to be done - debt reduction, austerity, structural reform - they have made good progress supported by the ECB’s OMT programme ... Using that as a base, the bonds screen well from a value stand-point.”
The premium offered by Italian 10-year bonds over benchmark German Bunds fell to its lowest in two months at 264 basis points. The equivalent spread of two-year yields shrank to its narrowest in two months at 162 bps.
Italian yields were 7-10 bps lower on the day across maturities, while most other euro zone yields were flat to slightly lower.
“Not a huge amount of flow behind this rally. The domestics are supporting the rally in the face of not so good news, but this is not a domestic-led only rally,” one trader said.
“The end of the speculation about Berlusconi created short-covering. At the end of the day policies are unlikely to change dramatically and foreigners are also gaining more confidence.”
Commerzbank rate strategist David Schnautz said an August lull in debt auctions after Italy canceled its mid-month sale also eased selling pressure on its bonds near-term but risks to the country’s political stability remained.
“The issuance calendar leaves some powder dry, enabling the domestics to manage the market,” he said.
“The reaction today is far from suggesting the market feels this is a non-event. Some investors may have been reluctant to make portfolio adjustments on a U.S. non-farm payrolls Friday, but they could still do it in the next couple of weeks.”
Italy is in a very strong position to weather any future political shocks, having completed around 80 percent of its funding target for this year, according to Reuters calculations.
Barclays strategists expect Italian redemptions and coupon payments for the remainder of the year to be higher than the amount of bonds sold by 18 billion euros ($24 billion).
Safe haven German Bund futures rose 22 ticks on the day to 142.61, having rebounded from session lows of 141.67 after data showed the number of U.S. jobs outside the farming sector increased by less than expected in July.
The data suggested the U.S. economy was still stuck in the low gear and that will make the Federal Reserve reluctant to withdraw monetary stimulus too quickly.