* Belgian bonds underperform after downgrade * Rating threats hang over euro zone bond markets * Bunds lower but seen testing highs again into year-end By Kirsten Donovan LONDON, Dec 19 (Reuters) - Belgian bonds underperformed their euro zone peers on Monday after Moody's cut the country's credit rating two notches, with markets braced for further euro zone downgrades, the threat of which should help safe-haven German Bunds rise into year-end. Belgian 10-year bond yields were 9 basis points higher at 4.42 percent, while the yield differential between French and German 10-year bonds widened 5 basis points to 127 bp after Fitch changed France's outlook to negative. Moody's downgraded Belgium to Aa3 with a negative outlook late on Friday, saying the euro zone debt crisis had increased funding risks for countries with high public debt burdens. Fitch had earlier warned it may downgrade France and six other euro zone states as it believes a comprehensive solution to the region's debt crisis is "technically and politically beyond reach". Markets were already awaiting a decision by Standard & Poor's on the 15 euro zone countries -- including France and Germany -- it put on review earlier this month. "Rating cuts are priced in to a degree but it's the start of a vicious cycle and it has implications for the (euro zone bailout fund), so it's not good and there's no reason why Bunds can't stay underpinned into year-end," a trader said. Spanish government bond yields continued to fall, with its 10-year bond now around 50 basis points lower since an auction last week attracted strong demand. The spread between 10-year Italian and Spanish debt has widened around 100 basis points over the last week as lower yielding Spanish paper sharply outperforms Italian bonds. "There's not volume behind it but the street's tidying up, finishing covering the short positions it was caught with going into the Spanish auction last week," said a second trader. Analysts say the demand for Spanish bonds could also be for collateral to use at this week's European Central Bank tender of three-year funds, although there are risks to such a move. "The risk of buying your domestic government bond and placing it into the (tender operation) are the daily mark-to-market on the position and the fact that their haircut will increase if the rating drops below A-," said ING rate strategist Alessandro Giansanti. Banks must account for daily gains or losses on their bonds, while the ECB increases its buffer against losses on lower-rated collateral assets. RIA Capital Markets' strategist Nick Stamenkovic said the market might have got ahead of itself in expecting the tender to offer continued support for peripheral debt. "(The market) has been short for a long time, and perhaps people are squaring positions," he said. "But there are a lot of headwinds early next year, uncertainty over sovereign downgrades, a lot of issuance ... and clearly no solution in Europe so I think this is a short-term phenomenon that won't persist much beyond the end of the year." European finance ministers will hold a teleconference on Monday to persue plans to enhance the IMF's crisis-fighting arsenal and press on with a drive for tighter fiscal rules. "A clear-cut decision would clearly be a positive while a risk remains that the bold announcements made during the latest EU summit could be further disappointed," Commerzbank strategists said in a note. March Bund futures were 45 ticks lower at 138.13 with a break above Friday's high of 138.86 needed to open the way to September's high of 139.19, and ultimately the euro-era high of 139.58 hit in November. Just 115,000 lots had been traded by 1115 GMT after volumes fell below 400,000 on Friday. "Neat consolidation between 133.00 and 139.00 is seen as a market preparing itself for another upside attack, taking prices and yields to unbelievable levels," said Nicole Elliott, technical analyst at Mizuho. But Societe Generale's analysts said the Bund could dip as low as the 136.94/137.12 support area before testing the highs. Ten-year Bund yields were 3.5 basis points higher at 1.899 percent.

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