FTSE falls as rising Italian yields spook investors

* FTSE down 0.8 percent

* Italian bond yields rise after auction

* Contagion fears knock banks, miners in volatile trade

* Smith & Nephew up on broker upgrade

By David Brett

LONDON, Nov 14 (Reuters) - Britain's top share index swung into negative territory on Monday, as equity markets echoed bond markets and reacted nervously to the latest Italian bond auction.

Italy paid a record 6.29 percent yield in its latest bond auction, below the 7 percent seen on secondary markets last week - a level that has triggered bailouts of Ireland and Portugal - but reflecting concerns over the country's ability to stave off bankruptcy and prevent the collapse of the euro zone.

"This disaster has not gone away, it has merely got a bit more stable temporarily. Italy has deeply divided politics at the best of times, and this is the worst of times," Louise Cooper, markets analyst at BGC Partners, said.

"Most investors do not know what the euro zone will look like in six or twelve months time - this uncertainty is why markets are so volatile."

The Italian debt auction was its first since former European Commissioner Mario Monti was asked to head an emergency government charged with tackling the debt crisis.

Further highlighting traders' lack of faith in politicians being able to solve the debt crisis, insurance against Italy defaulting on its debts rose five basis points on the day, while debt insurance for Spain, which is seen as the next most vulnerable country to Europe's debt contagion, rose 10 basis.

London's blue chip index fell 43.34 points, or 0.8 percent to 5,502.04 by 1202 GMT, led by banking and commodity stocks as investors exited riskier assets.

Barclays fell 2.4 percent, further hampered as Goldman Sachs cut its rating on the stock to "sell" from "neutral", saying it expects the bank to be dealt the biggest blow by reforms from the Independent Commission on Banking.

Other financials weakened too, with Schroders down 2.8 percent, while life insurer Legal & General shed 2.6 percent.

Legal & General could face a 200 million pounds bid battle with private equity house Bridgepoint for fund supermarket Cofunds, the Sunday Telegraph reported.

TESTING TIMES

Muddying the outlook for corporates, euro zone industrial production data supported expectations of a sharp contraction of industry towards the end of this year and a probable economic recession in Europe.

In the UK, the Bank of England is expected to downgrade its economic growth forecasts on Tuesday, BGC's Cooper said.

Heaping further pressure on the FTSE 100, U.S. stock index futures pointed to a weaker open on Wall Street on Monday.

In choppy trade, defensives stocks featured among the gainers with Vodafone, sought for in part for its dividend attractions, up 0.8 percent.

Smith & Nephew rose 2.3 percent, as Exane BNP Paribas upgraded its rating for the British medical products firm to "outperform" from "neutral", with the stock having underperformed by 20 percent in the year-to-date.

ITV rose 3.9 percent as Britain's biggest free-to-air commercial broadcaster said it expects to outperform the wider television advertising market in 2011 after a better than expected Q3 trading update.

"ITV's Q3 2011/9-month update contains enough for the bulls, whilst allowing the bears a little nibble too," Panmure says.

Lonmin rose 0.2 percent after the world's third-largest platinum producer beat expectations with a 59 percent jump in full-year earnings. (Editing by Hans-Juergen Peters)

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