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* European shares rebound after sell off
* German debt in demand ahead of Italy bond sale
* Euro vulnerable but off seven-week lows
By Marc Jones
LONDON, Feb 27 (Reuters) - Reassurance from the U.S. Federal Reserve about its stimulus programme helped stabilise the euro and European shares on Wednesday, as Italy prepared to test the reaction to its inconclusive election in the bond market.
Italy will auction up to 6.5 billion euros of new 5- and 10-year bonds at around 1000 GMT after gridlocked elections reignited fears about the euro zone debt crisis.
"Markets have started to price in risks of ungovernability of the country in the coming months, with possible domino effects on the rest of the euro area," said Newedge economist Annalisa Piazza.
"Political instability is expected to prevail ...and even a grand coalition government would be seen only as a temporary option, probably not able to continue the so-much needed reforms process."
Having fallen sharply on Tuesday following the Italian stalemate, European shares rebounded 0.4 percent as trading resumed with 0.8 percent rises in Milan's FTSE MIB and Spain's IBEX the leading the gains.
The mood was helped after Federal Reserve Chairman Ben Bernanke defended the U.S. central bank's monetary stimulus on Tuesday, easing financial market worries over a possible early retreat from bond purchases.
The euro also regained ground, rising 0.2 percent to $1.3085 having hit a seven-week low of $1.3017 on Tuesday.
In the bond market Italian yields, which rise as prices fall, inched up again, while German government bonds, a favourite of risk-adverse investors, also added to this week's hefty gains.
"Italy remains the centre of attention and I can't see it getting any better," one trader said. "Supply will be the main focus and ... it could be a bit of a problem."