UPDATE 1-Southern European yields edge lower as global market selloff eases

Demand for southern European government bonds picked up on Wednesday as a global market selloff prompted by Turkey's currency crisis eased, encouraging investors to pick up the extra yield on offer from Spain, Portugal and even Italian BTPs.

The debt of these countries tends to underperform in times of trouble as investors switch to higher-rated German Bunds, seen as one of the safest assets in the world.

As the Turkish lira recovered on Wednesday, European stock markets and low-rated debt strengthened.

"It's still volatile, but traders are watching the Turkish lira and that's what's moving the Bund and the BTP Futures up and down," said Commerzbank strategist Christoph Rieger. "On a day when parts of Europe are out on holiday, there's really nothing else to trade on."

Italian, Portuguese and Spanish government bond yields were 1-5 basis points lower, with Italian debt benefiting particularly.

The Italy/Germany 10-year yield spread, seen by many investors as the best bond market measure of risk sentiment, tightened to 267 bps on Wednesday, well below the 278 bps level reached on Tuesday, though it had climbed back up to 272 bps by late morning.

That said, there was no noticeable rise in high-grade bond yields even after fresh supply from Germany.

Germany sold a well-received 839 mln euros of bunds maturing in 2046 on Wednesday, with bids totalling 1.335 bln euros. The solid reaction had been expected with the resulting bid-to-cover ratio of 1.59 well above the 1.26 average.

Germany's 10-year yield fell slightly to 0.32 percent while long-dated debt was also unmoved at 1 percent.

This may be because the selloff of recent days has reminded investors of the value of holding German government bonds in case of such episodes in the future, said Rieger of Commerzbank.

"What's become clear after this risk-off episode is the inherent safety value you have in Bunds. I think this will structurally underpin the safety value that we have already observed in Bunds before," he said.

The rally in Italian debt was notable because yields had actually risen sharply in early trade after a bridge collapse in Genoa reignited a debate about European Union fiscal rules.

Investors started pricing in more spending by the Italian government on Wednesday after the tragedy in which at least 37 people were killed, prompting Deputy Prime Minister Matteo Salvini to question limits on the Italian budget.

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