* Step towards fiscal union seen positive longer term * Markets still looking for near-term crisis solution * Euro zone sovereigns face possible rating downgrades * Italian T-bill sale well bid, Dutch bill yields negative By Marius Zaharia LONDON, Dec 12 (Reuters) - German government bonds jumped on Monday as doubts remained that a European Union plan to enforce greater fiscal discipline could protect the euro zone from further shocks, including possible mass sovereign rating downgrades. Markets were on alert for a reaction from ratings agency Standard & Poor's, which on the eve of Friday's EU summit warned it might downgrade most euro zone countries if they did not come up with a decisive set of anti-crisis measures. In a sign of investor disappointment with the measures, yields on five-year Italian bonds rose above 7 percent. An auction of the same bonds on Wednesday will be a key test of investor sentiment. All EU members except Britain agreed to pursue stricter budget rules and a stronger fiscal union, but the capacity of the euro zone's bailout fund was capped and it was not granted a banking licence. That was seen putting further pressure on the European Central Bank to step up its purchases of Italian and Spanish government bonds to keep those countries' borrowing costs at affordable levels, at least in the short term. The ECB has not indicated it will buy more bonds. If Italy struggled to repay its debt, that would be felt across the euro zone due to the size of the Italian economy and banks' wide exposure to the country's debt. "We believe Italy is just as vulnerable, if not more, to a self-fulfilling panic in financial markets," said Nicolas Spiro, managing director at Spiro Strategy. "Nothing has been done to allay the growing concerns about Italy's huge funding needs next year." Bund futures were last 103 ticks higher at 136.40, with German 10-year yields down 8.9 basis points at 2.012 percent. "We remain of the view that we are not out of the woods yet and we will be looking for chances to put on more long Bund positions at some stage," one trader said. The Italian/German 10-year bond yield spread widened by half a point to 480 bps, while Spanish 10-year yields rose above 6 percent again. The cost of insuring euro zone debt rose, led by Italy's. Traders said the ECB bought short-term Italian debt. RATINGS With no sign of a decisive solution to address both short- and long-term concerns, things were likely to get a lot worse before they get better, analysts say. A Standard & Poor's analyst said the summit deal was a significant step in resolving a "crisis of confidence", but added that the EU will need more summits to resolve its debt problems and time was running out. Traders said they were still waiting for an official announcement from the S&P on how the "credit watch negative" warning will be resolved. "It is interesting to see what S&P's take will be on the summit because I'm disappointed (with the measures) and S&P have been very strong in their actions," Rabobank rate strategist Lyn Graham-Taylor said. Another ratings firm, Moody's Investors Service, said the summit measures were not decisive, leaving the cohesion of the bloc under "continued threat". It said it would revisit the ratings of euro countries in the first quarter of 2012. Underlining market fears, the Netherlands sold T-bills at negative yields as investors looked to preserve their cash in top-quality paper and avoid bank deposits. Italy, by contrast sold 7 billion euros worth of one-year T-bills on Monday, drawing decent demand from retail clients which were lured by the country organising a "BOT day" in which it scrapped fees for the bills at auction. "The question is will this help to stabilise sentiment? I don't believe so, given that those comments from (ECB President Mario) Draghi ruling out a bazooka during the ECB conference are still weighing on spreads," said WestLB rate strategist Michael Leister.

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