UPDATE 3-Investors increase pressure on Spain to seek aid
* Yields remain high at short-term debt auction
* Stocks fall sharply on aid request hesitation
* Analysts say ECB boost could fade if aid delayed
By Julien Toyer and Paul Day
MADRID, Sept 18 (Reuters) - Investors on Tuesday piled pressure on Spain to request international aid and trigger a European Central Bank bond-buying programme seen as inevitable to help the country finance its debt, with the benchmark 10-year bond rising to just over 6 percent.
Yields at the latest debt sale fell slightly from last month but remained at 2.835 percent on the 12-month bill and at 3.072 percent on the 18-month paper, offering little hope the country can finance itself at reasonable levels without seeking assistance.
The blue-chip Spanish index Ibex lost 1.1 percent, ending a two-week rally that began after the ECB said it was ready to help distressed euro zone countries.
Spain is at the centre of the euro zone debt crisis, now in its third year, with investors concerned that Madrid is unable to bring down its massive public deficit and control its soaring debt.
The government has already requested a European lifeline of up to 100 billion euros for its banks, but investors are not convinced that the country can meet its financial obligations and return to economic growth without international assistance.
ECB Governing Council member Luc Coene warned Prime Minister Mariano Rajoy against delaying triggering the programme on Monday, saying it would not take long for yields to rise if he did.
But Deputy Prime Minister Soraya Saenz de Santamaria said on Tuesday the government was still considering the terms of a European bailout, which would be a condition of ECB help, a stance that is weighing on investors' patience.
"I think we're in a bit of political limbo where markets are just waiting for Spain to ask for help, because ultimately if Spain doesn't ask, the verbal boost from the ECB is going to fade away," said Jo Tomkins, an analyst at consultancy 4Cast.
"The longer Spain holds out, the more impatient markets are going to get and the more frustrated markets are going to get."
The premium traders demand to hold Spanish over German debt fell to five month lows after the ECB announced the bond-buying programme on Sept. 6, but Rajoy has not made his position on aid clear, fuelling the renewed sell off.
The country's benchmark 10-year bond rose to around 6.03 percent before Tuesday's auction from 5.65 percent just 10 days ago.
The Spanish Treasury, taking advantage of improved market conditions since the ECB announced the programme, sold more than the top end of its target of between 3.5 billion and 4.5 billion euros of 12- and 18-month T-bills.
Although it was the highest amount sold at a T-bill auction since March and yields were slightly lower than a month earlier, demand for the paper was mixed and yields topped those in the grey market before the auction just a day earlier.
Investor frustration is likely to lead to demands for high premiums again at a bond auction on Thursday of to 4.5 billion euros of a new bond maturing 2015 and the benchmark 2022 bond.
The waiting game is a typical gambit for the cautious Rajoy, who is known for dragging out decisions as long as he can, both to seek the best political timing and to tire out opponents.
After he was elected last year he confounded market expectations by taking his time in announcing key cabinet members who would handle economic policy.
Earlier this year, despite heavy pressure from Brussels, he delayed presenting his tough 2012 budget until after elections in the country's most populous region, to try not to spook voters with spending cuts.
Some analysts believe he may mow be waiting until after October 21 regional elections, including in his home state of Galicia and the Basque Country, before taking a decision.
Rajoy's cautious style is not winning him much support and his popularity has plummeted since he took power in December.
According to a survey by Cicero research conducted amongst 1,000 Spanish adults over the summer, only 3 percent believed he was showing best leadership in the euro zone during the crisis.
A widening fiscal gap and mounting pressure from the business community and credit ratings agencies however leave Spain with little or no choice but to request European aid, analysts and sources say.
Economy Minister Luis de Guindos said last week the government would present on Sept 28 a new set of reforms to boost growth in line with European Commission guidelines.
The new measures are seen as a face-saving move to comply with European demands before making an official request.
"We believe Spain is paving the way to requesting a precautionary programme at the beginning of October, hopefully before the next Eurogroup meeting in Luxembourg," Barclays said in a research note.
"The presentation of a new reform agenda, therefore, looks to us in part as useful for the Spanish government to save some face, in the sense that it is very likely to be aligned on the conditionality requested in exchange for the bailout."
Rajoy has already passed austerity measures worth 10 percent of gross domestic product up to the end of 2014 and is reluctant to hand control to inspectors from the ECB, European Commission and International Monetary Fund.
Senior euro zone sources however insist this supervision is necessary to make sure the country meets its targets as well as to restore confidence after a series of communication mishaps by Rajoy and his government.
Adding to the country's problems, Spanish banks, awaiting the first funds from the 100-billion-euro European credit line, are coming under increased stress as bad loans rose to a record high in July and deposits from domestic companies and Spanish residents dropped.
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