* Greek default risk eased but aid doubts support Bunds
* Negative yield at Schatz sale underscores safety bid
* Italy hits auction target despite risk-averse mood
By Marius Zaharia and William James
LONDON, Nov 14 (Reuters) - Demand for low-risk German debt held firm on Wednesday, with the country selling two-year bonds that pay no interest as wrangling over Greek aid payments kept investors on edge.
The International Monetary Fund and the euro zone remain at loggerheads over how Athens should bring its debt down to a sustainable level, and a deal to release further aid payments to Greece remains some way off.
Concern the country may default and potentially be forced to leave the euro helped triple-A rated Germany sell 4.3 billion euros of new two-year debt at a negative yield.
Bidding at the auction was strong, pushing the yield below zero in an indication that investors prefer to keep their money in one of the safest places in the world even if that means losing a small portion of their initial investment.
“At the moment there is an intensifying concern about the future of the euro. It’s about Greece and how that’s going to play out,” said Alan McQuaid, chief economist at Merrion Stockbrokers.
In secondary markets, where investors trade already issued debt, German bonds had a quiet session but stayed close to their best levels in two months hit on Tuesday.
Bund futures were 8 ticks higher on the day at 143.22, off the previous session’s high of 143.48. Cash 10-year yields were 0.9 basis points lower at 1.335 percent, while two-year yields fell slightly to minus 0.036 percent.
The levels also reflect uncertainty over whether Spain will seek a bailout, the prospect of sluggish euro zone growth and worries that the U.S. faces recession-inducing automatic tax hikes and spending cuts of about $600 billion at the end of the year.
The December Bund future has risen by almost four points in the past month and analysts say it is unlikely to give up that ground any time soon.
“With Greece up in the air and the can being kicked down the road in Spain, it looks like the safety demand will remain very robust,” Commerzbank rate strategist Michael Leister said.
At the riskier end of euro zone debt, Spanish 10-year yields were 8 basis points higher at 5.96 percent.
Despite the risk averse mood, Italy - one of the euro zone’s struggling peripheral states - was able to hit its target of 5 billion euros with an auction of three-, 11- and 17-year paper.
For details of the Italian and German auctions, see and.
While Italy’s high debt levels and political landscape remain of concern for investors, yields on its bonds are well below their highs thanks to the European Central Bank’s promise to support the periphery if countries ask for financial aid.
“The result of today’s auction underscores the externally driven resilience of Italy’s bond market. Demand was solid and the yield on the three-year note resumed its downward trend and is at pre-crisis levels,” said Nicholas Spiro, managing director at Spiro Sovereign Strategy.
Italian bonds had rallied in the run-up to the sale, but the bid to cover of 1.5 on the three-year paper fell short of expectations and the bonds subsequently trimmed their gains.
The Italian 10-year yield was steady at 4.973 percent.