* German Bunds hit as Fed, stress tests fuel equities rally * German 10-year yields could rise to 2 pct in coming days * Italian yields slip after strong bond auction By Emelia Sithole-Matarise LONDON, March 14 (Reuters) - German 10-year bond yields spiked to a three-week high on Wednesday and could soon retest this year's 2 percent peak after the U.S. Federal Reserve sounded a less downbeat note on growth and most U.S. banks passed their annual stress test. Strong demand at a 6 billion euro auction of Italian debt from cash-rich banks, which drove its three-year borrowing costs to a near-17 month low, also dulled the allure of German benchmarks. German Bund prices extended the previous day's losses triggered by upbeat economic data after the Fed said that it expected "moderate" growth over coming quarters along with a gradual decline in the unemployment rate. "The Fed switch in its language to moderate in terms of economic performance in the U.S. hit the back end of U.S. Treasuries and the Bund is following suit," a trader said. "A relatively strong BTP auction this morning is also adding to the risk-on element." German 10-year yields jumped 10 basis points to 1.917 percent, its highest since Feb. 23. Some strategists and traders said that in the coming days yields looked set to hit the 2 percent level that has formed the upper end of their trading range this year as improved prospects for the global economy have fuelled a rally in riskier assets. The June Bund future fell more than a full point to 137.14, its lowest since Feb. 27. Selling in the contract accelerated after stop levels were triggered around 137.40, according to traders. With European equities hitting new 2012 highs and the risk of an imminent unruly Greek default averted, Bunds looked vulnerable to further losses, prompting Commerzbank strategists to maintain tactical short positions on the Bund."This combination of risk appetite coming back, on less uncertainty with regards to the Greek rescue package and a slightly more positive macro tone, are giving additional headwind to Bunds," said Rainer Guntermann, a strategist at Commerzbank. "We could well imagine that the trading range could test the upper side at 2 percent or slightly above on 10-year Bund yields." SPAIN/ITALY SWITCH Italian government bond yields fell across the curve , outperforming other peripheral euro zone issuers, after strong demand at its bond auctions - a five billion euro BTP maturing March 2015 and 1 billion euros of an off-the-run 2019 bond. BTP futures rose to 106.69 from 106.30 before the auction while the Italian 10-year yield was down seven bps on the day at 4.84 percent, outpacing the Spanish equivalent which was little changed at 5.16 percent. Credit Agricole strategists said they saw good value in the new Italian three-year issue, and recommend switching out of Spain's Jan. 2015 bond which has not been tapped since last August. "There is a 25 bps pick-up from the Spanish to the Italian issue, making this possibly the best value Spain-Italy switch at this time. At anything above 10bps, the switch makes sense and should be held medium term," they said in a note. Italian bonds have outperformed their Spanish counterparts this year as market attention refocuses on Madrid after it missed its 2011 budget deficit target. Spanish 10-year bonds yield over 30 bps more than their Italian counterparts, after trading almost 200 bps lower at the start of the year.