×

UPDATE 1-Spanish bonds underperform Italy as Catalan concerns grow

* Spain-Italy bond yield spread at tightest level since June 27

* Austria to test duration demand with first ever 100-year bond

* ECB's Constancio speech could give clues on speed of taper

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr

LONDON, Sept 12 (Reuters) - The gap between Spanish and Italian government borrowing costs narrowed to its tightest level in more than two months on Tuesday on growing investor concerns over an upcoming independence vote in the Spanish region of Catalonia.

About one million Catalans rallied in Barcelona on Monday, waving red and yellow striped flags and banging drums, in a show of support for independence after Madrid moved to block a referendum on the region's split from Spain.

The concern for investors is that this could bring new political uncertainty for the country's minority government and potentially undermine the Spanish recovery story.

The Catalonian independence referendum, which has been declared illegal by the Spanish government, is scheduled to go ahead on Oct. 1.

"Though Madrid is doing its best to stop the independence bid, it will still get a lot of attention," said DZ Bank strategist Daniel Lenz, adding that some investors are switching from Spanish to Italian government bonds as a result.

"It could eventually become a huge problem for companies and taxpayers, and there is the prospect of Spanish troops going into the (Catalonian) region, even," he said.

The Spain-Italy 10-year government bond yield spread tightened to 50.7 basis points in early trade on Tuesday, the tightest level since June 27.

Most euro zone bond yields were 1-2 basis points higher on the day, pulling further away from Monday's 2-1/2-month lows as unease about an unwinding of ECB stimulus and relief that North Korea did not conduct another missile test at the weekend hurt safe-haven assets.

Increased supply from euro zone countries may also be pushing yields higher as investors sell their existing holdings to make space for the new bonds.

The yield on Austria's long-dated bonds increased further on Tuesday as the country's debt management office goes ahead with the marketing of a 100-year bond. This would make it the first euro zone country to sell a "century bond" publicly via a syndication.

A successful sale would demonstrate that demand for super-long bonds, whose prices are hyper-sensitive to interest rate changes, remains solid even as central banks start winding down their crisis-era stimulus measures, bankers said.

Also on Tuesday, the Netherlands is due to sell 2-3 billion euros of 10-year government bonds while Germany is set to hold a 500 million euro sale of inflation-linked bonds maturing in 2046.

In the afternoon, European Central Bank Vitor Constancio is to speak at a conference, and investors will look for further clues on how rapidly the bank will unwind extraordinary monetary stimulus.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.bi z / c m s / ? p a g e I d = l i v e m a r k e t s

(Reporting by Abhinav Ramnarayan; Editing by Mark Trevelyan)