* Investors snap up 3.36 bln euro of 10-year German Bunds
* Yields lowest at auction since July 2012
* German sale follows solid demand at Dutch 10-year sale
By Emelia Sithole-Matarise
LONDON, March 20 (Reuters) - Investors snapped up 3.36 billion euros of 10-year German bonds on Wednesday, driven into the euro zone's lowest risk debt, after Cyprus rejected the terms of a bailout needed to avoid default.
Efforts to rescue the island were thrown into disarray on Tuesday after its lawmakers rejected a levy on bank deposits that was among the conditions for a 10 billion euro European Union bailout.
Although market reaction to the crisis has been relatively muted, with investors believing a solution will eventually be found, investors still worry that considering penalising savers as part of a bailout sets a precedent and could reignite the bloc's debt crisis.
But without a solution, Cyprus risks default and a banking collapse.
These concerns spurred demand for the least risky government bonds, despite their low yields.
The German bond sale drew bids worth 1.6 times the amount allotted to investors compared with 1.2 times when the paper was sold in February and a 1.45 average at this year's auctions. It was sold at an average yield of 1.36 percent, the lowest at auctions since July last year. For details see
"Investors are prepared to park their funds in Bunds near- term because of the uncertainty in Cyprus and the limited options they have. That certainly is reflected in today's healthy demand," said Nick Stamenkovic, a rate strategist at RIA Capital Markets.
Bund futures, which had been lower all day, last traded at 144.35, down 27 ticks. German 10-year yields held steady at 1.37 percent in the secondary market, two basis points up.
The 10-year yield fell as low as 1.34 percent on Tuesday, its lowest so far this year, and two-year yields briefly turned negative for the first time since January as investors sought refuge in one of the region's most liquid assets.
"The cheapening that we've seen this morning combined with the ongoing fear about Cyprus contributed to ... a good result despite yields trading close to the year's lows," said Michael Leister, a rate strategist at Commerzbank.
The German auction followed a strong sale on Tuesday of a new Dutch 10-year bond that raised 6.52 billion euros, above the Dutch Treasury's initial target of 5 billion.