UPDATE 2-Italian, Spanish yields hit lowest since June Fed meeting
* Italian, Spanish yields dip to pre-Fed meeting levels
Signals from central banks are the leading market driver
* Bunds weaker as European equities rise
By Marius Zaharia
LONDON, July 23 (Reuters) - Italian and Spanish 10-year bond yields hit their lowest levels on Tuesday since the last Federal Reserve meeting, when the U.S. central bank laid out plans to scale back monetary stimulus.
Since the June 18-19 meeting, Fed Chairman Ben Bernanke has made clear the plans were not set in stone and the European Central Bank has taken the unprecedented step of saying interest rates will stay at record lows for an "extended period".
The guidance from both central banks has eased investor worries that global liquidity could shrink to levels that would cause significant harm to the euro zone's weaker states.
Italian 10-year yields fell 1 basis point to 4.33 percent, having hit their lowest since June 19 at 4.29 percent as trading began. Spanish equivalents also hit a five-week low, at 4.54 percent, before trading flat at 4.60 percent.
"The market has certainly put Fed tapering into a better perspective," UniCredit rate strategist Luca Cazzulani said.
The yields were still about 30-40 bps above levels in May before Bernanke hinted that the pace of Fed asset purchases could slow later this year. Analysts said yields were unlikely to revisit those levels.
"The bias is for lower yields, but one has to be careful though because the environment is different than it was a few months ago when investors expected abundant liquidity for a very prolonged period," Cazzulani said. He saw the floor for Italian yields at around 4 percent.
CENTRAL BANK DOMINATION
Spanish and Italian yields have fallen roughly half a percentage point over the past month despite a corruption scandal putting pressure on Spanish Prime Minister Mariano Rajoy and worries over the fragility of Italy's ruling coalition.
The two debt markets also showed resilience to a political crisis in Portugal, which president Anibal Cavaco Silva cooled over the weekend by ruling out early elections.
This shows markets are currently driven more by moves by the world's major central banks, which have doubled or even trebled their balance sheets in the past six years, than by factors such as political risk or weak growth prospects, analysts said.
However, some warned that without signs of economic recovery, this may not last.
The Bank of Spain projected a 0.1 percent quarter on quarter economic contraction in April-to-June.
"The situation where (markets) are focusing only on what the central banks are doing may not be sustainable," ICAP strategist Philip Tyson said.
German Bund futures were 35 ticks lower on the day at 143.85 as European equities hit fresh seven-week highs.
On trader said sales of top-rated debt in Britain and the Netherlands also weighed on Bunds in a thin market. Britain was selling 4 billion pounds of 2044 index-linked gilts via syndication, while the Dutch raised 1.8 billion euros of eight- and 29-year bonds.