* German Bunds weak 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 Marius Zaharia and 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 Rome's 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. "Equities are hitting new highs, the sentiment has improved so it makes sense for Bunds to catch up with the U.S. eventually if the U.S. remains where it is," one trader said. "It's certainly possible to see yields above 2 percent." German 10-year yields jumped 13 basis points to 1.95 percent, its highest since Feb. 23. Bund yields remain almost 30 bps below U.S. T-notes and some 40 bps below UK Gilts. The June Bund future fell 140 ticks to 136.84, its lowest since Feb. 22. 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. But the depth of problems the euro zone still faces should prevent Bund yields from rising much above 2 percent in the longer run. "I would be relatively neutral as from a fundamental perspective growth in Europe is expected to be subdued, a recession (is likely)... and also there are still some disinflationary forces around like the private sector deleveraging," said Michiel de Bruin, who manages 25 billion euros as head of euro government bonds at F&C Netherlands.SPAIN VS ITALY 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 5 bps on the day at 4.86 percent, outpacing the Spanish equivalent which was up 2 bps at 5.17 percent. Spain has massively underperformed Italy this year and analysts think Thursday's auction of three-, four- and five-year debt will probably prove weaker than Italy's. Spanish 10-year bonds now yield over 30 bps more than their Italian counterparts, after trading almost 200 bps lower at the start of the year, reflecting the switch in market attention to Spain's poor economic data and its 2011 budget goal miss. Nevertheless, domestic banks are expected to take advantage of the relatively higher yields and take down the supply in a smooth fashion. "The underperformance of Spain should prove to be supportive of what in any event will be small auctions with a maximum size of 3.5 billion euros compared to recent maximum targets of around 4.5 billion euros," Barclays Capital rate strategist Huw Worthington said. Credit Agricole strategists 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 10 bps, the switch makes sense and should be held medium term," they said in a note.