S&P downgraded on Friday the ratings of Italy, Spain, Portugal and Cyprus by two notches and those of France, Austria, Malta, Slovakia and Slovenia by one notch each. Germany's triple-A rating remained intact.

The downgrades were broadly expected and German Bund futures consolidated after hitting a record high of 140.23 on Friday. But strategists and traders said the contracts could still reach new peaks as investors were reminded of the fragility of the euro zone's anti-crisis tools.

Analysts say the downgrades will almost certainly lead to a cut in the EFSF euro zone bailout fund's rating as it would be politically difficult for the still top-rated Germany or Finland to make up for France's guarantees to the fund.

"I can't see any situation in which the EFSF doesn't get downgraded," Rabobank rate strategist Lyn Graham-Taylor said.

"Once the EFSF is downgraded it will be another risk-off move which will probably affect particularly Spain and Italy. We all knew it was too small ... but it has become even less of a credible rescue mechanism."

Italian two-year yields were down 4.6 basis points on the day at 4.378 percent, having opened at around 4.6 percent. Ten-year yields were up a shade at 6.7 percent in Italy and at 5.25 percent in Spain.

Traders said the European Central Bank was seen buying Italian and Spanish debt in the 3-10-year tenors.

"If it wasn't for the ECB aggressively buying bonds the periphery would be where it was earlier," a trader said. "The ECB is the only buyer today."

The equivalent French and EFSF spreads over Germany were little changed, but in credit default swaps markets, the cost of insuring Italian, Spanish, French, Austrian and Belgian debt against default rose.

GREECE AGAIN

In another blow to confidence in the currency union's chances of muddling through the crisis, talks on a debt swap by private creditors seen as crucial to avoid an unruly Greek default broke up without agreement in Athens on Friday.

A Greek default could lead to a break-up of the euro zone and may trigger a deep recession within the bloc.

Graham-Taylor expected the Greek worries to send peripheral spreads wider in the near-term, while Rabobank's favourite trade, a Dutch/French spread widening, could "easily" have some 20 basis points more to go from about 100 bps.

"I can see some convergence between Spain and Italy, the Greek talks are not looking hugely positive."

Bund futures were last 14 ticks lower at 139.80, having hit a record high of 140.23 on Friday. Ten-year German cash yields were little changed at 1.78 percent.

Momentum indicators such as the MACD (moving average convergence divergence) suggested Bund futures were likely to move further up into uncharted territory in the next few weeks, UBS technical analyst Richard Adcock said.

The 138 percent Fibonacci extension at 142.26 is the next target beyond the current record high, Adcock added.

"Technically, Bunds still look quite attractive, but yields are very low now," said Nick Stamenkovic, bond strategist at RIA Capital Markets.

"We need a deterioration in the situation in euro land or we need to see signs that the global economy is heading into recession for yields to break below 1.70 and I don't think we're going to get that this week."