* Spanish yields rise after Moody's warns on fiscal targets * Bunds' rebound seen short-lived on resilient equities * German 10-yr yields could rise to 2.20 pct in coming month By Emelia Sithole-Matarise LONDON, March 20 (Reuters) - Italian and Spanish bonds came under pressure on Tuesday, prompting a rise in low risk German debt, as Italy's Mario Monti started talks with unions over labour reforms that could make or break his government, stoking worries about fiscal slippage. Investors were lured back into German bonds after 10-year yields broke last week above 2 percent, the upper end of the year's trading range to that point. But the rebound from last week's sell-off could be short-lived with yields expected to remain above 2 percent in the coming month against a backdrop of improved U.S. and German economic data that has lifted U.S. equities to within sight of record highs. Still, yields on bonds issued by Spain and Italy rose on investor caution as Prime Minister Monti met unions over labour reforms seen as crucial to helping the country revive economic growth and pay down its massive debt. "Labour market reforms are absolutely pivotal to improving the medium-term growth outlook which has been very poor recently," said RIA Capital Markets strategist Nick Stamenkovic "So if we see signs of further structural reforms going in place that will help Italy, but if we see signs that Mr Monti starts to water down structural reforms the market will take that very badly and Italian bonds will come under pressure." Italian 10-year yields were last up 4.3 bps at 4.88 percent , widening the spread over German Bunds by 7 bps to 286 bps. The equivalent Spanish yield was up 4.7 bps at 5.22 percent after ratings agency Moody's said Spain's fiscal outlook remained challenging despite recently softened deficit targets. Moody's said, however, that the new target did not affect its A3 bond rating with a negative outlook because a deviation from targets had already been taken into account. Some strategists expect Italy to keep outperforming Spain after data showed Spanish banks' bad loan rates rose in January to their highest since August 1994, suggesting the sector is not yet out of the woods as the country slides into recession."We're quite constructive still on Italy," said UBS strategist Gianluca Ziglio. "If we get a smooth process in terms of the labour market reform then there's no reason why BTPs shouldn't tighten even more against Bunds and outperform Spain as well because we think the Spanish problem is much more important and relevant than issues in Italy." HIGHER GERMAN YIELDS? June Bund futures were last up 19 ticks on the day at 135.79 while the 10-year German cash yield was down 1.4 bps at 2.03 percent, retreating from this year's high of 2.07 percent reached last week. "We're seeing a bit of a bounce off last week's sell-off but I don't think it's going to be very pronounced. I wouldn't recommend investors chase this rally," said RIA Capital Markets strategist Nick Stamenkovic. "Whilst the Bank of England, the Fed and ECB are not going to raise rates any time soon the chances are that any further monetary accommodation starts to lessen and one of the key supports for core government bonds starts to fade and yields will start to move modestly higher over the next few weeks." He saw the German 10-year yield testing 2.20 percent over the next month. Credit Agricole strategists said that if Bund yields broke above an important technical level over the coming days, it would suggest they had entered a new higher range. "In this context, the 10-year Bund would have to stay above 2 percent. Further validation of last week's move would be if the Bund can test its 200-day moving average - around 2.12 percent - like the 10-year T-note and UK gilt have done," they said in a note.