EURO GOVT-ECB reassurance, doubts about Fed lift periphery bonds
* ECB comments, U.S. GDP data support euro zone bonds
* Italian debt auction received well by the market
* Bund futures continue recovery from 8-month lows
LONDON, June 27 (Reuters) - Lower-rated euro zone bond yields fell sharply on Thursday on prospects of prolonged ultra-loose ECB monetary policy and doubts the Federal Reserve could easily wind down its stimulus.
A smooth, albeit lacklustre, debt auction propelled Italian bonds into the day's top three performers, lagging only the less liquid Portuguese and Greek bonds.
Euro zone yields rose across the board last week after the Fed announced plans to slow bond purchases. Its policy outlook became less certain, however, after a downward revision to first quarter U.S. growth on Wednesday.
With European Central Bank policymakers repeatedly saying this week that withdrawing extraordinary easing measures was a "distant" prospect, analysts expect peripheral debt to recover further before the bank meets next week.
"There's a return in risk appetite after the data yesterday showed a lagging GDP ... and going into the ECB meeting. The Italian auction also went well and we've had people looking to switch into Italy out of Spain," one trader said.
Ten-year Italian yields were 14 basis points lower on the day at 4.57 percent, while equivalent Spanish yields fell 10 bps to 4.71 percent.
The spread between the two hit the bottom of their 30 bps range of the past four months at 10 bps this week, as pre-positioning for the auction led to Italian underperformance. Italy's 10-year spread over Germany narrowed to 285 bps, having hit its widest since mid-April at 307 bps on Wednesday.
Italy sold 5 billion euros worth of five- and 10-year bonds, meeting demand in line with this year's average, but paying the highest borrowing costs since March.
"They sold the maximum intended amount, which is a good thing, but ... bid/covers stayed largely unchanged. That's perfectly understandable in the volatile market environment," said KBC rate strategist Mathias van der Jeugt.
"Overall it's job done and ... markets seem to be happy."
While markets focused on central bank policy outlooks, European Union leaders agreed to force investors and wealthy savers to share the costs of future bank failures.
However analysts are wary of cheering any EU-level agreement made before the German elections in September.
"The headlines are very upbeat, but we see it as rather worrying," Societe Generale rate strategist Ciaran O'Hagan said.
"If you read the statement it is all in conditional tense... It's rather a series of aspirations than a detailed agreement and it could all change."
Bund futures rose 42 ticks to 141.45, with recent ECB comments supporting a recovery from Monday's eight-month lows of 139.90. One trader said month-end buying also helped.