Mon Aug 12, 2013 5:59am EDT
* Spain debt risk premium fall follows similar move in Italy
* Funding position, improving data favours Spain, Italy debt
* Upcoming euro zone GDP data seen confirming stabilisation
By Emelia Sithole-Matarise
LONDON, Aug 12 (Reuters) - The risk premium on Spanish bonds hit its lowest in two years on Monday, after a similar move in Italy, as a dearth of new debt sales and improving economic data favoured lower-rated bonds.
The move lower gained momentum on expectations data this week will confirm the euro zone economy is pulling out of its longest recession, keeping German yields high.
Spanish 10-year bonds' yield premium over German Bunds fell 5 basis points to 277 bps - its least since early August 2012, after the European Central Bank's vow to do whatever it took to save the euro defused the euro zone crisis.
Spanish and Italian bonds' yield premia - a gauge of the extra return investors demand for lending to lower-rated euro zone governments - have more than halved from levels hit at the height of the debt crisis in 2011 and mid-July 2012.
The bonds have been supported by reduced supply, with Spain having completed over 70 percent, and Italy 80 percent, of their 2013 funding targets. Both have cancelled mid-August debt sales.
Their stronger financial positions and the ECB's as yet untested bond-buying backstop allowed Spain and Italy to fend off pressure from political tensions.
Spain has been embroiled in a political funding scandal and the conviction of former Italian premier Silvio Berlusconi has threatened to topple the country's shaky coalition government.
Neither has seen much impact on demand for its debt, with Italy's one-year borrowing costs falling to their lowest since June at a sale of Treasury bills on Monday.
"The trend at least in the near term is for these spreads to narrow further," RIA Capital Markets strategist Nick Stamenkovic said. "There are some political risks on the horizon, particularly German elections in September, but this should be a temporary obstacle."
BUNDS IN RETREAT
The Italian 10-year yield gap over Bunds was 3 bps tighter at 248 bps, matching Friday's low which was its narrowest since July 2011, also helped by signs the euro zone's third largest economy was emerging from recession.
While strong economic data is often negative for low-risk government bonds, recession has complicated efforts by weaker euro zone states to put their finances in order.
Spanish and Italian bonds were seen further outperforming Bunds, with euro zone second-quarter growth data on Wednesday expected to confirm the currency bloc's economy is stabilising.
"If the data continues to surprise to the upside then 10-year Bund yields will gravitate higher in coming months," a trader said.
German 10-year yields were last 2.4 bps up at 1.71 with Bund futures 26 ticks lower at 142.01.
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