April 5, 2012 / 10:45 AM / 5 years ago

EURO GOVT-Spanish yields rise as worries grow; Bunds rally

* Spanish yields rise as debt worries grow

* Pressure set to continue after auction demand waned

* Bund yields mark 2012 low, futures hit contract high

* France sells 8.4 bln euros of bonds

By Kirsten Donovan

LONDON, April 5 (Reuters) - Spanish government bond yields rose further on Thursday after investors worried about the country's ability to meet budget targets held back at debt auctions the previous day, rekindling funding concerns for lower-rated euro zone states.

Spanish bonds are likely to remain under pressure in the near term after borrowing costs jumped at the auctions , although some of the sharp rise in yields may be due to thin trading prior to the Easter holiday.

Spanish 10-year yields were 12 basis points higher at 5.84 percent, after rising around 30 bps on Wednesday. The yield differential over Bunds, at 411 bps, was its widest since late November, before the European Central Bank flooded the banking system with a trillion euros of three-year cash.

"There's been a lot of negative news on Spain over a sustained period of time but market sentiment was being buoyed by strong auction results until yesterday," said Rabobank rate strategist Lyn Graham-Taylor.

"It's quite a dangerous time and if the market starts to panic then the sky's the limit (for borrowing costs), although you may see some policy action come into play."

The Spanish/German yield spread was around 475 bps in November, even with the ECB buying bonds in the secondary market, a programme that has been mostly dormant this year.

ECB President Mario Draghi said on Wednesday that any talk of a withdrawal of the exceptional crisis-fighting measures would be premature.

Equivalent Italian yields, which are being dragged higher in tandem with Spain, were up 13 basis points at 5.52 percent. Shorter-dated paper in both countries underperformed.

"It looked like we were over the worst of it with the three-year (ECB funding operation) and Greece (debt restructuring) out of the way ... but now with the focus on Spain and Portugal we're looking at a different kettle of fish," a trader said.

The increasing jitters supported safe-haven German debt, pushing June Bund futures to a contract high of 139.26 after the market broke above Wednesday's 138.74 high.

They were last 72 ticks higher at 139.14, still at their highest levels since late February on a continuous contract basis. Ten-year yields were down 6 basis points at 1.75 percent, having marked a new 2012 low of 1.73 percent.

"Cracks are appearing again, Spanish spreads over Bunds are wider than they've been all year, so it's not looking pretty," a second trader said.

"There's no reason not to buy any dips in Bunds. People are unlikely to want to be short going into the long weekend given the backdrop."

Another trader cautioned that in the thin pre-Easter trading, price moves were being exaggerated although there were some selling flows of peripheral paper with both domestic and international accounts selling Spanish and Italian paper.

France, still a relative safe haven, found decent demand at its 8.4 billion euro bond sale although yields rose into the sale as dealers tried to cheapen paper. The 10-year spread over Bunds was last 11 bps wider at 127 bps, although much of that was caused by the drop in Bund yields.

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