UPDATE 2-Italy 6-mth yields almost double on Fed-induced fears
* Italy sold 8 billion euros of six-month bills at higher rates
* ECB's reassurances help euro zone debt market
* Longer-dated yields likely to rise at Thursday's sale
MILAN, June 26 (Reuters) - Italy's short-term debt costs almost doubled at an auction on Wednesday as expectations of a reduction of U.S. monetary stimulus continued to weigh on riskier assets.
On Tuesday both Italy and Spain had to pay much higher rates to lure investors and Italian borrowing costs are likely to rise again on Thursday when the treasury offers up to 5 billion euros of longer-dated debt.
After a 10-month-long rally, sentiment on higher-yielding bonds has soured as investors adjust to expectations the Federal Reserve will tune down the amount of liquidity injected into the financial markets in coming months.
Markets are expected to remain edgy going into the summer with investors jittery over the chances of recovery in a euro zone that runs the risk of falling further behind an improving U.S. economy.
As Rome returns to markets on Thursday, investors will also keep a careful eye on Italy's fragile political backdrop after former Prime Minister Silvio Berlusconi was handed a seven-year jail sentence on Monday.
"The general market sentiment is negative and I prefer to be short on peripheral bonds as we approach the summer, when the market is thin and choppy," said a trader at an Italian bank.
Against this backdrop, Italy sold 8 billion euros ($10.5 billion) of six-month bills at 1.05 percent, up from 0.54 percent at a similar auction one month ago.
The yield, the highest since February, came in line with the secondary market, while demand was 1.36 times the offer, down from a bid-to-cover ratio of 1.58 one month ago.
The premium Italy's 10-year bonds pay over safer German Bunds fell under 300 basis points after the sale. It rose to 310 bps on Tuesday, the widest since April.
Until May, Italian and Spanish bonds had benefited from the massive liquidity injected by central banks around the world and the European Central Bank's commitment to shield the weakest euro zone countries.
These factors sent Italy's 10-year yields to a 2013 low of 3.70 percent with the spread to German Bunds tightening to 250 bps.
With all eyes on the Federal Reserve, investors turned to the ECB on Tuesday as it moved to infuse confidence in nervous investors.
"The market seemed to have calmed down a bit today thanks to the reassurance by the European Central Bank that its monetary policy will remain accommodative for a long period," said Alessandro Giansanti, fixed-income analyst at ING.
ECB President Mario Draghi said on Tuesday the central bank was far from reeling in its ultra-easy policy and reiterated the same dovish message on Wednesday.
Investors shrugged off for now doubts over Italy's exposure to derivative contracts which, according to media reports, could cause a loss of 8 billion euros for the country, traders said.
Italy risks losses potentially running into billions of euros on derivatives contracts it restructured at the height of the euro zone debt crisis, the Financial Times and Italian daily La Repubblica reported on Wednesday, quoting an Italian treasury document.
Italy's treasury denied on Wednesday its use of derivatives as a hedge on its 2-trillion-euros debt pile posed any risk to public finances.