EURO GOVT-Spanish bonds extend post-auction rally - Christmas Flowers Italy

LONDON, Dec 16 (Reuters) - Spanish and Italian government bonds rallied on Friday one day after a strong Spanish auction helped sentiment for peripherals even as the threat of a downgrade from Standard & Poor's hung over euro zone sovereign debt.

S&P last week warned it could carry out a mass downgrade if the European Union summit disappointed. Given that the outcome has been insufficient to restore market confidence, most analysts are expecting an imminent move.

Fitch Ratings also downgraded a series of banks in Europe and in the United States late on Thursday.

Ahead of the European Central Bank's ultra-long 3-year financing operation next week, however, traders said peripheral bonds could find some support and price swings could be exacerbated by thin liquidity one week before christmas flowers italy .

"The Spanish auction yesterday was very strong, part of the explanation for that being that the paper was eligible to use at the ECB (European Central Bank) as collateral," one trader said.

"There's this talk about the 3-year LTRO, it's kind of like a QE (quantitative easing) backdoor, they can use the money to buy periphery. It's like a no-brainer, you take the money at 1 percent and you buy Spain at 6-7 percent. That keeps supporting the periphery."

Spanish 10-year government bonds jumped, with yields slumping 20 basis points to 5.24 percent, extending the previous day's decline after Spain surprised markets by selling far more than the amount targeted in its last bond sale of the year, though its borrowing costs remained high. Two-year Spanish yields shed 19 basis points to 3.62 percent.

Italian 10-year government bonds rose, pushing yields 15 basis points lower to 6.85 percent, and two-year yields were down 34 basis points at 5.41 percent.

Italy faces a vote of confidence on its austerity package, but with Mario Monti's government enjoying an overwhelming majority in both houses of parliament, the vote should easily pass in the Chamber of Deputies this afternoon before it moves to the Senate.

DOWNGRADE THREAT

The rise in Italian and Spanish bonds came despite the threat of a downgrade of Standard & Poor's, which last week warned it could cut the ratings of a series of euro zone sovereigns, including Germany and France.

Fitch Ratings, the third-biggest of the major credit rating agencies, on Thursday downgraded a series of large banks including Deutsche Bank, BNP Paribas, Credit Suisse and Goldman Sachs.

"I wouldn't be at all surprised seeing (sovereign) ratings getting adjusted to the downside," David Schnautz, strategist at Commerzbank said.

But analysts say a rating cut of German debt would unlikely have a long-term impact on Bunds, pointing to the United States which still enjoys safe-haven flows despite a downgrade to its ratings earlier in the year.

"As soon as we see a level shift for the triple-A's, that probably would not mean much for Bunds at all," he said. "The benchmark status for Bunds is without any question in the euro space."

The German Bund future was up 16 ticks on the day at 137.79 christmas flowers italy blogs .

"We are in 'buy the dip' mode right now and we suggested 137.33 as the level to attempt this yesterday," FuturesTechs said in a research note. "Nothing (has) changed and we (would) still be looking to play this to the long side, aiming for a retest of 139.58."