* Stability of Italian government at risk
* Demand falls at zero-coupon Italian debt sale
* Safe-haven Bunds rise on Syria tensions
By Ana Nicolaci da Costa and Marius Zaharia
LONDON, Aug 27 (Reuters) - Italy’s debt premium rose to its highest in nearly a month on Tuesday as the country made a lacklustre return to debt markets after a summer break, reflecting concerns over the government’s survival.
German Bund futures, meanwhile, benefited from their safe-haven appeal as the possibility of Western military action against the Syrian government hit shares worldwide.
“People are jumping out of the riskier products that they have been building positions in for the past few months,” said David Keeble, global head of fixed income strategy at Credit Agricole.
“We have got this Syria (situation) blowing out emerging markets and really I would say it’s just a fairly typical risk trade ... Italy is underperforming more than Spain because of the whole political risk (there).”
Italy’s fractious ruling coalition struggled on Tuesday to bridge differences over a housing tax that threatens to create a new crisis for a government already severely strained by the legal turmoil surrounding former premier Silvio Berlusconi.
Italy sold zero-coupon two-year bonds at 1.87 percent, a marginally higher yield than last month while demand as measured by the bid/cover ratio fell.
Ten-year Italian yields rose 7 basis points to 4.46 percent. Italy’s yield gap with equivalent German bonds was at 261 basis points - its widest since Aug. 2.
The premium investors demanded to hold Spanish bonds over their Italian equivalent neared zero as Italian debt continued to underperform, partly due to political woes.
The 10-year Spanish/Italian yield spread was at 4 basis points - its tightest since March 2012.
“Investors are not that keen on buying Italian bonds at the moment, especially taking into account the political jitters, which are higher than in any other European country,” DZ Bank rate strategist Christian Lenk said.
He said a truer test of investor sentiment would be Thursday’s auction of up to 6 billion euros of five- and 10-year bonds, which he expected to show similar “mixed” results.
Other peripheral bonds also fell with 10-year Spanish yields up 4 basis points at 4.50 percent and equivalent Irish yields 6 bps up at 4.06 percent.
German Bund futures settled 49 ticks higher at 140.54, while cash 10-year German yields fell 4.7 bps to 1.85 percent, even as data continued to show an improved economic outlook.
Germany’s Ifo business survey showed sentiment at its highest level in 16 months, beating expectations - the kind of data which helped to push German yields to 1-1/2 year highs of 1.98 percent last week.
Concerns that Western powers were inching closer towards military action against Syria over a suspected chemical weapons attack offered support to safe-haven assets on Tuesday.
“It seems a bit odd to see Bunds rising like that after the Ifo figures ... but equities are being hit because of the Syria problems,” one trader said.
The rise in Bunds also came after three consecutive weeks of selling.