Spanish yields rise as summit hopes fade

LONDON (Reuters) - Spanish government bonds came under pressure on Monday while safe-haven German Bunds rallied sharply, after markets hopes for an EU summit this week to produce convincing steps to halt the euro zone debt crisis dwindled.

The summit - on Thursday and Friday - is meant to sketch out a roadmap towards economic union in the currency bloc and to show regional leaders are united and determined to do whatever it takes to restore confidence in the battered single currency.

But the outcome of a meeting held between France, Italy, Spain and Germany on Friday did not bode well for market sentiment with Germany rebutting the idea of common debt issuance, although Chancellor Angela Merkel did agree to a 130 billion euro package to revive growth.

"Germany is still sounding tough and there's Spanish bank downgrades still to come," a trader said. "That means there's some opportunistic sellers of Spain and Italy after the strength last week but really we've not seen that many flows today."

Ten-year Spanish government bonds fell, pushing yields almost 30 basis points higher to 6.64 percent, while two-year yields were up almost 40 bps.

Spanish bonds rallied for four straight days last week, partly on hopes that Italy's push to let the bloc's bailout fund buy troubled states' sovereign bonds in the secondary market would gain traction.

Spain's banking problems and deteriorating finances have put it at the forefront of the euro zone debt crisis, prompting the country to formally request European aid for its banks on Monday but without specifying the exact amount.

Moody's is expected to cut the ratings of all Spanish lenders on Monday night - following its recent downgrade of the sovereign - adding to pressure on the sector.

Analysts expect Spain will ultimately be forced to seek a full sovereign bailout which would use up much of the euro zone's available rescue funds.

BUNDS BOUNCE

Bunds rebounded after three weeks of losses as the market adjusted its expectations for the summit.

Merkel will meet French President Francois Hollande on Wednesday as they try to square their differing positions on the crisis ahead of the wider meeting of leaders.

Renewed appetite for safe-haven bonds saw German Bund futures settle 127 ticks higher at 142.15, with 10-year yields 10 basis points lower at 1.47 percent.

"We have seen some rather stern rhetoric come out of Germany and Friday's mini-summit...saw absolutely no progress on any of the fronts the market would have hoped to see some developments in," Richard McGuire, strategist at Rabobank said.

"We head into summits full of expectations, which is negative for core paper and supportive for peripherals, but so far the summits have tended to disappoint."

Italian bonds were also down on the day ahead of a bout of supply later this week, with 10-year yields rising 20 bps to 6.0 percent and two-year yields up half a percentage point.

Italy will sell zero coupon and inflation linked bonds on Tuesday in a first test of market appetite for its paper ahead of a BTP auction on Thursday.

The Treasury is likely to have to pay more to get the bonds away amid concerns about contagion from Spain even though domestic investors are likely to support the sale .

"Some of the Italian widening today will be the result of concession building ahead of the supply," the trader said.

Belgian bonds were one of the session's better performers after the country sold 2.8 billion euros of bonds. Ten-year yields were 3.5 basis points lower at 3.25 percent, only outperformed by Germany and the Netherlands.

(Editing by Ron Askew)

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