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ANALYSIS-Confounding consensus, ECB taper talk leaves peripheral bonds unscathed

unscathed@

* Spain/German bond yield gap tightest since March 2015

* Peripheral bonds outpace top-rated peers in euro area

* German yields rise as taper talk relieves squeeze

* Carry trades boost demand for peripheral debt

* Peripheral bonds still vulnerable to taper - analysts

LONDON, July 25 (Reuters) - After months of fretting about the impact on euro governments' relative debt costs when the European Central Bank eventually runs down its bond-buying programme, the expected quake never happened as the "taper talk" began.

A month after ECB chief Mario Draghi rattled markets by suggesting monetary stimulus was about to be scaled back, the premium investors demand for holding Spanish bonds instead of top-rated German peers is less than 100 basis points. That's its lowest since March 2015 -- when the ECB began buying up bonds to boost inflation and economic growth.

The yield gap between Italian bonds - viewed as particularly vulnerable to an unwinding, or "tapering", of monetary stimulus - and German is its narrowest since December.

This was not expected. Banks estimated in February that euro zone yields would be 20 to 50 basis points higher without the ECB bond-buying, albeit below estimates from a year earlier of 75 to 100 bps higher.

"This is something that has been bugging me for some time, because you would expect with a tightening of peripheral bond spreads at the beginning of the programme, you would also see the reverse at the perceived end of the programme," said ABN AMRO senior bond strategist Kim Liu.

Bond market participants cite a number of reasons for the unanticipated move in bond spreads.

First, the spread tightening has been driven by a sell-off in German bonds. Investors are positioning for ECB tapering to relieve a scarcity of German debt that the bond-buying scheme created.

Germany, the euro zone's biggest economy, is the main source for the ECB's asset purchases. A scarcity of eligible German debt for the scheme has pushed down yields. But since Draghi's speech in Portugal last month, 10-year Bund yields have doubled, suggesting a reassessment of the policy outlook.

At the same time, a rise in the euro, pushed up by expectations of tighter monetary policy, has encouraged investors to borrow money in low-yielding assets and buy higher-yielding ones - such as southern European bonds.

"The really telling thing after (last week's) ECB meeting was that while peripheral spreads tightened, which you could say was because Draghi was seen as dovish, the euro rallied dramatically," said Iain Stealey, co-manager of JPMorgan Asset Management's Global Bond Opportunities Fund.

"Perhaps this reflects a push into European assets."

Alongside this, a perception that any tapering will be prolonged to buffer the bloc for as long as possible has boosted risk appetite.

Relative political calm in the euro zone - albeit with an Italian election due next year - compared with Brexit upheaval in Britain and President Donald Trump's travails in the United States, is also seen as positive for riskier euro zone debt.

But the sharp tightening in spreads also raises risks of an even sharper blowout, once details of the ECB's plans for winding down quantitative easing emerge.

ECB policymakers see October as the most likely date to decide whether to start winding down its stimulus, four sources with direct knowledge of the discussion told Reuters last week .

The reasons for expecting a sell-off in peripheral bonds when the ECB does taper have not changed. Peripheral economies are weaker than their higher-rated peers, their debt issuance is higher and the risk of political instability, especially in Italy, is greater.

"If you look at the fundamentals - the issuance picture, the political risks in the periphery - all these things are going to come into play when a big player like the ECB pulls out," said Jan von Gerich, chief strategist at Nordea.

Stealy at JPMorgan Asset Management said concerns about tapering and looming Italian elections are reasons he has a neutral position on peripheral bonds.

ECB bond-buying has helped hold down borrowing costs across the bloc and been a buffer at times of heightened market volatility, for instance after last year's UK Brexit referendum.

The true test of investor appetite for peripheral debt will come when the ECB lays out its tapering plans.

"For me the situation doesn't feel right," said ABN AMRO's Liu. "In the long run, if the ECB exits the market ... spreads will go wider. It's just that the move has been postponed."

(Reporting by Dhara Ranasinghe, editing by Larry King)