* Offers 4.50-6.25 bln euros of five-, 10-year bonds
* Five-year yields set to rise, 10-year seen roughly stable
* Vulnerable to contagion from Greece, Spain
By Valentina Za
MILAN, May 30 (Reuters) - The euro zone's intractable debt problems will keep Italian borrowing costs high at a bond sale on Wednesday, with analysts warning of spillover risks ahead if Spain's banking woes were to lead it to push up its government debt issuance.
The threat of Greece exiting the euro zone together with Spain's problems have refuelled wariness of weaker euro zone borrowers among international investors, who are estimated to now hold only about a third of Italy's total debt.
Support from domestic buyers is expected to ensure sufficient demand for the Treasury's offer of up to 6.25 billion euros of five- and 10-year bonds. But five-year yields are set to climb above 5 percent, rising sharply from a month ago.
"We are convinced Wednesday's auction will meet good demand," said Matteo Regesta, a strategist at BNP Paribas in London. "What we fear is Spain's worsening situation. It is hard to imagine that Italy could go unscathed if Madrid were to tap the euro zone rescue fund or be forced to raise more debt."
A government source told Reuters on Tuesday that Spain would issue more debt to recapitalise nationalised lender Bankia.
Italian bonds have outperformed Spanish ones recently but the world's fourth-largest public debt and a shrinking economy make Italy vulnerable to worsening sentiment towards peripheral euro zone debt.
"Italy has registered a massive re-widening in spreads due to contagion effects from the Greek political situation," Newedge Strategy analyst Annalisa Piazza said in a note.
Newedge said it expects "high volatility to be the main market driver in the coming weeks and Italian spreads versus Germany have limited room to re-tighten."
Italian 10-year bonds trade about 4.5 percentage points above German ones. The yield gap for two-year bonds is 4 percentage points, as concerns about Greece and Spain have taken a bigger toll on shorter maturities.
Higher yields increase the attractiveness of Italian bonds for domestic investors at a time when they cannot count on redemption flows to reinvest into fresh issuance.
Italy successfully placed 12.75 billion euros in new debt this week, but yields hit their highest since December both at a six-month bill auction on Tuesday and at a sale of two-year paper the previous day.
Borrowing costs are set to climb also at the sale of a new five-year bond on Wednesday. The June 2017 bond traded around 5.3 percent on the eve of the auction. Italy last sold a five-maturity a month ago at an average 4.86 percent yield.
The Treasury will also sell a new tranche of its Sept. 2022 bond. The 10-year benchmark traded at around 5.9 percent late on Tuesday, not far from an auction level of 5.84 percent at the end of April.