* Spanish, Italian yields fall, but stay at high levels * Euro FinMins meeting provides no surprises * French, Austrian, Belgian bonds may rally further By Marius Zaharia LONDON, July 10 (Reuters) - Spanish and Italian government bond yields dipped on Tuesday on hopes Germany's top court will give its blessing to efforts to deploy euro zone rescue funds more flexibly, but room for further falls looked limited. The Constitutional Court has begun a hearing into whether the euro zone's bailout scheme and budget rules are compatible with German law. Finance Minister Wolfgang Schaeuble told the court that any significant delay in approving the measures could fuel financial market turbulence. Spanish 10-year yields were 16 basis points lower on the day at 6.90 percent, while their Italian equivalents fell 13 bps to 5.97 percent. "There was some speculation about the ESM (bailout fund) being treated with more urgency, but volumes are low and the market is still holding up all right," one trader said. "There's no real momentum behind the move." Earlier, euro zone finance ministers agreed to grant Spain an extra year, until 2014, to reach its deficit reduction targets and set the parameters of an aid package for its banks that it is hoped will prevent Madrid needing further aid. But with 10-year Spanish yields close to the key 7 percent level beyond which countries such as Portugal or Ireland were eventually forced out of capital markets, investors continued to fret about a potential sovereign bailout. "We've heard nothing concrete (from the ministerial meeting) so ... the tension is turning more and more to the constitutional issues in Germany and the implementation risk," DZ Bank rate strategist Michael Leister said. "If there is a positive ruling it won't have much of an impact because it is more or less the consensus. But if it implies further headwinds for the broader solution to the debt crisis it would raise pressure on (peripheral) spreads." Bund futures were last 12 ticks lower at 143.87, still within sight of the one-month high of 144.28 hit on Monday. HUNT FOR YIELD Two-year Spanish and Italian bonds rallied, outperforming longer-dated paper and catching up with a wider move in short-term debt in the euro zone following the European Central Bank's cut in interest rates to record lows last Thursday. Two-year German bond yields traded just below zero, while equivalent French paper yielded 19 basis points. The latter yielded about 390 bps less than Italian short-term bonds and 470 bps less than Spanish two-year bonds. "The front end of Italy and Spain is too cheap really given where other markets are trading. If you argue everything else is at or going to zero then at some point you're going to see some hunting for yield," one trader said. Ultra-low yields in Germany are mainly pushing flows into markets perceived as riskier but not as risky as Spain or Italy, where investors can find better returns. French, Austrian and Belgian bonds have all rallied across the yield curve since the ECB's rate cuts. Belgian 10-year yields were 10 bps lower at 2.78 percent, near the record low of 2.736 percent hit on Friday. This compares with levels around 6 percent seen in November, during the previous wave of the euro debt crisis. "This (trend) can persist as long as the bid for safety continues to dominate ... meaning that you have no choice but to search for yields in this kind of market," BNP Paribas rate strategist Patrick Jacq said.

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