* Spain, Italy yield gap with Bunds rises but moves contained
* Faith in ECB QE, other firewalls limit contagion (Updates prices, adds quote)
By Emelia Sithole-Matarise
LONDON, July 6 (Reuters) - Italian, Spanish and Portuguese bond yields each rose 10 to 20 basis points on Monday after an overwhelming Greek vote against EU-prescribed austerity measures that could set Athens on a path out of the euro zone.
The moves were modest, within the trading ranges of the past three weeks, as investor faith in the European Central Bank’s firewalls protected the weaker euro zone economies.
The resignation of Greece’s combative Finance Minister Yanis Varoufakis was considered a step towards renewed negotiations with creditors, though it remained to be seen how tough a stance Prime Minister Alexis Tsipras would take.
“Our feeling is that somehow there will be a compromise that will allow Greece to stay in the euro,” said Jim Kochan, chief fixed income strategist at Wells Fargo Asset Management. “Second, if there is some contagion, one would think the ECB would react aggressively.
Around 61 percent of those voting in the Greek referendum rejected the bailout conditions demanded by Greece’s creditors. Tsipras said that would strengthen the country’s negotiating position on a new aid deal with the European Union and International Monetary Fund.
Many economists, including those at JPMorgan, said it would probably hasten Greece’s exit from the euro zone, although French Finance Minister Michel Sapin said the vote would not automatically lead to an exit.
Bankers said the European Central Bank’s response would be key to the effect Greece had on the rest of the euro zone. The ECB holds a conference call on Monday to decide how long to keep Greek banks afloat.
Some in the market said the referendum result would boost the standing of anti-austerity parties elsewhere, such as Spain’s Podemos, and erode ongoing reforms. Spain holds a national election in November.
Spanish and Italian 10-year yields were 10-12 basis points higher at 2.37 percent and 2.38 percent , respectively. Their yield premiums over German Bunds rose 13-15 bps as investors sought safe-haven debt, but they remained below eight-month highs hit a week ago.
Yields on 10-year bonds from Portugal, the other market most vulnerable to contagion from Greece, were up 21 bps at 3.19 percent.
“We kind of had a trial run of this last Monday, and the fact markets didn’t completely (tank)... probably gave people a better feel for how today would work out and that there wasn’t going to be this crazed panic,” said Owen Callan, a senior analyst at Cantor Fitzgerald.
“Also, with Varoufakis stepping down, it does give the sense that a deal could be done, or even is already being worked on.”
Last Monday, peripheral euro zone bond yields jumped 20-30 basis points following Athens’ introduction of capital controls and pledge to hold the referendum.
The yields are now more than double the lows hit in March following the launch of the ECB’s 1 trillion-euro asset purchase programme. But they remain below the levels of around 7 percent reached in the debt crisis in 2011/2012.
“Greece is small - less than 2 percent of euro zone GDP - and direct private sector exposure to Greece is modest. Furthermore, the ECB is much better equipped to stem contagion than it was in 2011-12 and is likely to react forcefully if market turbulence leads to a warranted tightening of monetary conditions,” said Paul O’Connor, co-head of Henderson Investors multi-asset team.
“Still, given that few investors constructed their portfolios with a Greek ‘No’ vote in mind and most are likely to be reducing risk at this time of the year, we think it is right to remain cautious until this fluid, fast-changing situation has been more clearly resolved.”
The uncertainty led investors into safe-haven government bonds, pushing German 10-year yields 3 bps lower to 0.77 percent .
Trading in Greek government bonds was still suspended, as the country’s markets regulator requested last week after Greece defaulted on an IMF loan. But dealers indicated Greek two-year yields at 51 percent, 16 percentage points higher and 33 percentage points above 10-year yields.
The sharply inverted bond curve is a classic indicator that investor fear they will not get all their money back. (Additional reporting by Marius Zaharia and John Geddie; Editing by Larry King)