(Adds CDS prices, quotes)
* Spanish yields rise after downgrade warning
* Bund rally above 130 as risk aversion reigns
* No relief in sight for periphery ahead of summer lull
By William James
LONDON, July 29 (Reuters) - Bund futures rose on Friday as investors switched out of lower-rated debt, with Spain the focus of concerns that the euro zone debt crisis appeared to be spreading and fresh delays in a deal to avert a U.S. default adding to the risk-averse tone.
Spreads on high-yielding euro zone debt widened after Moody's warned it could cut Spain's credit rating, and the country's prime minister added to the negative tone by calling early elections for November, saying the move was to promote stability.
"This (Moody's) move just heightens the uncertainty in the market ... there are a lot of reasons why the Bund is up today," said DZ Bank strategist Glenn Marci.
"In relation to Spain, people from within the (euro area) are piling up their holdings of Bunds, and also there may be some risk-averse flows coming from the U.S."
Fresh delays in Washington's political battle to avoid default limited market liquidity.
In the euro zone, the crisis continued to show signs of spreading as Moody's placed Spain's Aa2 rating on review for a possible downgrade, citing weak growth and the risk of a sustained rise in funding costs.
Bund futures FGBLc1 rose over half a point, briefly breaking through the 130 barrier for only the second time since last November. By 1100 GMT the contract had traded around half the average number of lots, highlighting the uncertainty surrounding the U.S. debt situation.
"The appetite for fresh positions is pretty low now going into the month-end and with the U.S. deadline coming up on Tuesday," a trader said.
The rating action on Spain comes just one week after European policymakers unveiled a package of measures aimed at shoring up Greece and halting the spread of the region's debt crisis.
Since the announcement of the deal, which was initially well received by markets, doubts about how the plan can be implemented have seen Italian and Spanish yields rise back towards their euro-lifetime highs.
"Nervousness was already in the market, and both yields and spreads in Spain and Italy were under upward pressure, and it's difficult to see that this trend will stop today," said Commerzbank strategist Rainer Guntermann.
Spanish 10-year government bond yields were last 4 bps higher at 6.09 percent, with similar moves seen along the curve. Italian yields also rose, nearing the 6 percent mark.
The cost of insuring Spanish debt against default was last 18 bps up at 363 bps while Italian CDS rose 8 bps to 307 bps.
Both CDS prices implied a BBB credit rating according to Markit, supporting the view that the selloff in Spanish debt had been limited by the markets already gloomy prognosis.
With Spain set to issue debt next week, market participants said it was hard to see a reversal of the rise in peripheral yields over the medium term.
Questions over plans to beef up the euro zone's rescue fund and provide a backstop for Spain and Italy looked set to remain unanswered as European markets head towards the summer lull, keeping uncertainty high and spreads wide, analysts said.
POSITIONING FOR A US DEAL
The flight-to-quality trade saw Bunds outperform their U.S. counterparts, widening the gap between 10-year German debt and higher-yielding Treasuries to 32 bps.
The latest delays to the process of raising the U.S. debt ceiling and avoiding default were keeping investors cautious ahead of an August 2 deadline, but any resolution was unlikely to cause sentiment to reverse given the negative news in the euro zone periphery.
"Resolution of the debt ceiling debate will certainly help, but there's so many obstacles to climb it's difficult to see any all-clear being given to euro zone markets in the coming months," said Investec's chief economist Philip Shaw.
With no end in sight to euro zone worries, investors were unlikely to take up short positions on German debt despite the risk of a sell-off if a deal is struck over the weekend, a trader said. (Editing by John Stonestreet)