* Bunds sink half a point to session low after weak auction
* Uncertainty over near-term outlook weighs on Bund auction
* Spanish yields fall as Madrid launches 5-year dollar bond
By William James
LONDON, Feb 20 (Reuters) - German debt futures fell and a sale of 10-year bonds struggled on Wednesday as investors kept to the sidelines before events likely to determine demand for low-risk assets in coming weeks.
The 4.04 billion euro bond sale drew less demand than expected, falling short of previous auctions and narrowly avoiding becoming the first German auction in five months to see bids fall short of the total amount issued.
Bund futures fell to a session low of 142.24, down 58 ticks on the day, extending early losses after the auction result was announced.
Market participants attributed the weak demand to a reluctance to take big positions before Italian elections this weekend, and the need for clearer signals from economic data before judging progress across the currency bloc.
“This is a weak result with the auction only just being covered on a real basis,” said Rabobank rate strategist Lyn Graham-Taylor, although he highlighted the bond sale came at a competitive price compared to secondary market levels.
“This (weakness) may be explained by the general risk-on tone of recent times and also that many investors are looking to sit on the fence heading into the Italian elections.”
Tuesday’s upbeat investor sentiment data from Germany was also cited as a factor behind the sluggish demand, and further encouragement from purchasing managers’ index number on Thursday and a German survey on Friday could extend the fall in Bund futures.
Nevertheless, worries that the Feb. 24-25 Italian election will produce a fragmented coalition government with limited scope to reform were likely to keep Bunds within the 142 to 143 range that has held over the last two weeks, analysts said.
Despite Italy’s looming election, the country’s 10-year bond yields were 2 basis points lower on the day at 4.39 percent, continuing a pattern of buyers emerging to take advantage of price dips.
DZ Bank said shorter-dated Italian bonds looked attractive as overall market sentiment improved and in anticipation of a fresh rally if former Prime Minister Silvio Berlusconi’s election campaign fails to win him influence.
Elsewhere among the region’s struggling peripheral states, Spanish 10-year bond yields were 5 bps lower at 5.16 percent before a wave of supply expected to hit the market in coming days.
On Thursday Spain will sell up to 4 billion euros of conventional bonds and also opened order books on a new five-year bond denominated in U.S. dollars.
The dollar bond issue is the first by Spain since September 2009 and will enable Madrid to diversify its investor base and tap into the largest community of yield-hungry emerging markets funds.
Commerzbank estimated that market conditions would make the dollar deal only marginally cheaper than issuing in euros, but would be taken as another positive step towards meeting its 2013 funding requirement.
“Besides the small funding arbitrage, the deal would also come along with some relief on the conventional (Spanish government bond) supply front for this year, as Spain has to sell another record-high amount,” the bank said in a note.
Spain has so far raised 22.7 billion euros of a 121 billion target.