* Japanese buying of Spanish bonds at record high for a 2nd month
* They bought French and Italian bonds while selling German ones
* Italian bond sell-off could scare off many investors - analysts
* Signs emerge of Japanese returning to U.S. bond markets
By Hideyuki Sano
TOKYO, June 8 (Reuters) - Japanese investors bought a record amount of Spanish bonds in April, at the start of Japan's financial year, and they returned to U.S. bonds after heavy selling the preceding six months, Ministry of Finance data showed on Friday.
They bought 350 billion yen (2.70 billion euros) ($3.19 billion) of Spanish bonds in April, a record for the second straight month after March's 282 billion yen. They were attracted by the higher yields Spanish bonds offer, compared to core countries in the euro zone.
Their buying surpassed that in longtime favourite French bonds, of 298 billion yen.
Since October, Japanese investors have flocked to euro zone bonds, shifting from the U.S. markets, because of the former's attraction for currency hedging.
Investors can earn an extra return of about 0.3 percentage point through hedges on the euro. For hedging against the dollar, they need to pay about 2.6 percentage points.
That gap more than offset euro zone bonds' lower nominal yields compared to U.S. Treasuries, and sparked an 8.1 trillion yen outflow from dollar bonds and 4.9 trillion yen flows into euro denominated bonds during October-March.
In April, Japanese bought 169 billion yen of Italian bonds, the most in two years. They sold 672 billion yen of German bonds, the first net selling in seven months.
However, their foray into Southern Europe may halt after Italian bond prices sank last month on worries about an early election.
Some long-term investors saw that as a bargain-hunting opportunity. Japan Post Insurance Co, one of Japan's largest investors, said it was looking to buy short-term Italian government bonds after the sell-off made them inexpensive.
But analysts think the latest Italian sell-off is likely to scare off many other risk-averse Japanese investors.
"It will be impossible for many investors to increase Italian bonds after seeing such high volatilities," said Makoto Noji, senior strategist at SMBC Nikko Securities, adding they are likely to shift to other assets such as U.S agency bonds.
The data showed Japanese investors returned to U.S. bonds in April after six months of heavy selling.
They bought 703 billion yen of U.S. bonds, though that's a fraction of their October-March selling of 8.86 trillion yen.
Their buying in U.S sovereign bonds were totalled 172 billion yen, suggesting a bulk of their buying was in corporate, mortgage and agency bonds. ($1 = 109.80 yen) (1 euro = 129.5091 yen)
Reporting by Hideyuki Sano; Editing by Richard Borsuk