Asian shares rose Tuesday, but gains were capped by concerns that surging bond yields could stifle debt-ridden Italy's fund-raising ability and throw the euro zone deeper into financial turmoil, while Greece struggled to pick a new leader.

MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS>, was up 0.4 percent while Japan's Nikkei stock average <.N225> fell 0.17 percent.

As focus shifted to concerns over Italy's borrowing costs, Asian credit markets remained sluggish, keeping a widening bias on the spreads on the iTraxx Asia ex-Japan investment grade index - a gauge of investor appetite for risk. The spread was slightly wider on Tuesday.

Equities trading volume was low generally, with gains linked to local factors while overall investor mood remained cautious.

Investors are largely taking a wait-and-see stance right now. Neither buying nor selling appetite is strong as they watch developments in Europe, said Han Beom-ho, a market analyst at Shinhan Investment Corp.

Chinese shares were supported by hopes for a year-end rally on optimism that Beijing may selectively loosen its grip as inflationary pressures ease and growth moderates.

Seoul shares <.KS11> were lifted Tuesday by gains in shipyards and LG Electronics (066570.KS) while Hong Kong shares <.HSI> were supported by China-linked names.

Gains in equities and a firmer dollar eased appetite for safe-haven gold, taking bullion off its 6-1/2-week high hit on Monday. Gold inched down 0.2 percent to $1,790 an ounce on Tuesday after rising over 2 percent the previous day.

The dollar index <.DXY> against six key currencies inched up 0.1 percent.

ITALIAN SPREADS WIDEN

The euro fell 0.1 percent to $1.3758 against the dollar as investors feared that political uncertainty in Italy and Greece could derail Europe's efforts to implement a bailout plan to prevent a Greek default.

The single currency fell as low as $1.3679 on Monday, but stayed within the $1.3608 and $1.3866 range of the past week.

Italy's Prime Minister Silvio Berlusconi defied intense pressure to resign on Monday, pushing yields on Italy's 10-year bonds to 6.67 percent, their highest level since 1997.

Italy, the third largest economy in the euro zone, has the biggest government bond market. Borrowing costs hitting the 7 percent level were widely seen as unsustainable for its debt.

The threat to the FX market, obviously, is that a country with nominal GDP growth of just 1.8 percent at the last count and debt totaling 120 percent GDP, cannot sustain 6.5 percent yields for long, said Kit Juckes, strategist at Societe Generale.

Investor jitters over Italy's debt has helped widen the spread of bonds issued by the European financial stability facility and German government bonds by about 50 basis points over the past month.

The spread on Italian government bonds over Bunds shot up to 490 basis points on Monday, compared with around 350 basis points a month ago.

European policymakers were increasing pressure to put Italy under full surveillance, with Jean-Claude Juncker, the chairman of Eurogroup finance ministers saying the European Central Bank would take part in monitoring economic reforms along with the European Commission and the International Monetary Fund.

While attention has shifted to Italy, bargaining over the choice of a new prime minister in Greece maintained the risk of a political vacuum.

Market jitters lingered over a lack of funding to bolster the bailout fund. No pledges have been received yet for new money.

This has prompted euro zone finance ministers to speed up legal and technical preparations for leveraging the bailout fund to around 1 trillion euros by the end of November to deploy it in December. This may help shield vulnerable but solvent economies such as Italy and Spain from a possible Greek default.

France announced new austerity measures designed to preserve its wobbly AAA credit rating, without which the euro zone might no longer be able to bail out its weakest members.

(Additional reporting by Ian Chua in Sydney and Jungyoun Park in Seoul; Editing by Kavita Chandran)

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