LONDON: German Bund futures slipped on Tuesday as December's sharp rally faded, but the euro zone's crippling debt crisis was expected to limit falls as refinancing pressure grows on the bloc's lower-rated sovereigns.
The drop added to losses in the previous session, but underlying demand for the relative safety and liquidity of German debt was set to remain supportive as the region's debt problems continue to fuel low-risk investment strategies.
Bund futures were 16 ticks lower at 138.03 after rallying more than 5 points in December to within sight of November's record high of 139.58.
"The consolidation in Bunds following the turn of the year could still run another day," Commerzbank strategists said in a note, but added that any falls were likely to be short-lived.
"Next week - at the latest - the focus should shift to the debt problems of the euro zone periphery again with the Italian and Spanish bond auctions scheduled."
Italy's borrowing costs, hovering near the 7 percent level, are a crucial gauge of sentiment with the country needing to refinance more than 100 billion euros of maturing bonds and interest payments in the first quarter of the year.
Italian 10-year bonds last yielded 6.90 percent, slightly lower on the day.
Markets will be watching to see if banks use a huge 489 billion euro injection of three-year loans from the European Central Bank to buy Italian and other lower-rated debt, or continue to deposit the cash at the ECB and pay their own debts.
SUPPLY PRESSURE
Germany and France will sell 2012's first bonds this week, with market participants pointing to the 13 billion euros of supply as another factor weighing on top-rated debt.
Ahead of the supply, the French/German 10-year yield spread widened 6 basis points to 140 bps, its widest since December 8.
The real supply crunch begins next week with Spain and Italy - the two countries at the forefront of concerns about the region's ability to escape its debt problems - both due to issue bonds.
Spanish debt has outperformed Italian paper on the perception that it poses less of a systemic risk to the currency bloc, and has less demanding refinancing needs in 2012. But, after unveiling a larger than expected budget deficit and a grim outlook, that outperformance could be reversed.
"You could argue that Spain's done too well, with talk of a deficit above 8 percent of GDP. We're looking to be short Spain from here," a trader said.
Ten-year Spanish bonds carried a yield 174 bps lower than their Italian equivalent, just off levels seen last week of nearly 200 basis points -- the biggest yield gap between the two countries' bonds since the launch of the euro.
Spanish 10-year yields were 2.6 bps higher on the day at 5.16 percent.
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