* Spread between U.S., German bonds hits highest level on record
* Italian bank worries stoke buying of safe-haven German Bunds
By Dion Rabouin
Dec 28 (Reuters) - U.S. Treasury debt yields were little changed on Wednesday in light year-end trading, but worries in Europe about rescue plans for shaky Italian banks drove the gap between benchmark U.S. 10-year notes and their German counterparts to the widest ever.
U.S. 10-year notes gained fractionally in price, with their yields retreating about 2 basis points to around 2.55 percent. Elsewhere across the yield curve, U.S. debt prices were unchanged to slightly firmer ahead of a $34 billion sale of 5-year notes in the afternoon.
Flows into safe-haven German Bunds in European trading were more sizeable, however, in the first trading day there since the Christmas break. That pushed the spread on yields between U.S. and German 10-year paper to a record wide 237 basis points as German 10-year yields fell to their lowest since Nov. 9.
Earlier this week, the European Central Bank told ailing Italian lender Monte dei Paschi di Siena that its capital shortfall had risen to 8.8 billion euros ($9.2 billion) from the 5 billion euros indicated previously. This raised questions about whether the 20 billion euros earmarked by the Italian government would be enough to cover the funding requirements of all the country’s banks.
Moreover, U.S. investment strategists say the widening yield gap across the Atlantic is being driven by divergent monetary policies. The ECB is pushing ahead with further bond buying, while the Fed is signaling the pace of rate hikes here should pick up in 2017.
“It’s come from movement on both sides,” said Robert Tipp, chief investment strategist at Prudential. “Normally the yields are very highly correlated between the U.S. and Germany but we’ve actually seen a divergence where Treasury yields have continued to inch higher but Bunds (prices) have rallied and yields have gone in the opposite direction.”
The spread between U.S. and German government debt widened to the record levels in bonds with maturities from two to 10 years.
Meanwhile, the U.S. yield curve was slightly flatter after the debut of the new 2-year note, which was sold by the U.S. Treasury on Tuesday with the highest yield at auction since October 2008. The spread between 2- and 10-year notes touched the narrowest in two weeks.
The new 2-year Treasury note was little changed in price to yield 1.286 percent. Benchmark 10-year Treasury notes rose 4/32 in price to yield 2.549 percent.
Prices on the 30-year Treasury bond rose 12/32, with yields dipping to 3.119 percent.
Reporting by Dion Rabouin in New York; Editing by Dan Burns and Chris Reese