* Spanish debt auction finds strong demand
* Spanish debt rallies, safe-haven Bunds fall
* ECB seen keeping rates steady at record lows
By Marius Zaharia
LONDON, Jan 10 (Reuters) - Spain’s benchmark bond yields fell to 10-month lows on Thursday after Madrid kicked off its challenging 2013 funding programme in force with a strongly bid auction of mostly two-year debt.
Safe-haven Bunds fell after the auction, but losses were limited as investors kept positioning light before a European Central Bank meeting later in the day when key interest rates are expected to stay at record lows.
Spain sold 5.82 billion euros worth of new 2015 bonds and re-opened 2018 and 2026 debt - more than the 4 billion-5 billion euros targeted as investors bid more than at previous auctions of similar-dated paper.
Improved appetite for high-yielding assets this year after the United States averted a fiscal crisis with a last-minute budget deal was the main reason behind the strong result, analysts said.
“It was definitely a strong auction, they exceeded the targeted amount which is a good sign for the first auction of the year,” said Norbert Aul, rate strategist at RBC Capital Markets.
“Supply will take its toll and will be heavy going forward, however we have a positive outlook for Spanish paper.”
Two-year debt led the rally in Spain with yields falling 25 basis points to 2.214 percent, while Spanish 10-year yields fell below 5 percent for the first time since March 2012.
While the market responded well to the auction results, longer-term concerns about Spain’s ability to complete the most challenging funding programme in the euro zone this year remained.
The two-year bond, which was the focus of the sale, falls within the remit of the OMT, an ECB short-dated bond buying programme that could be activated if Madrid asks for a bailout from its euro zone partners.
While that backstop ensures constant demand for two-year paper, appetite for longer-term debt - more sensitive to foreign investor demand - is little tested.
“The real test here will clearly be the issuance of a new 10-year bond,” Commerzbank rate strategist Michael Leister said.
“Two-year paper is not a robust indicator (of how solid Spain’s market access is), so from a more strategic point of view you don’t get much out of this auction.”
Spain has not auctioned a new 10-year bond since November 2011, focusing on shorter-dated paper for which it usually finds strong domestic demand. That strategy is risky, however, as the amount of debt to be paid back near term is constantly growing.
The other key event of the day was the ECB rate-setting meeting. The bank is expected to keep its key refinancing rate at a record low of 0.75 percent and its deposit facility rate at zero percent as the euro zone economy has shown some signs of stabilising recently.
However, investors will be looking for any clues from President Mario Draghi on the likelihood of future rate cuts. In December, he said the ECB had discussed a deposit rate cut, sending two-year German yields into negative territory.
“Yields have moved higher since the lows in December, there’s been less safe-haven bids and more of a positive tone. So the market would be surprised if he were bearish,” Investec fixed income strategist Elisabeth Afseth said.
A pessimistic assessment of the euro zone economy from Draghi may push Bunds higher, but the most likely scenario is a cautiously upbeat tone from the ECB chief.
“The ECB might be a bit more upbeat, so chances of a rate cut might recede. You could argue it’s a negative (for Bunds) but I‘m not convinced. It’s all about future data,” the trader said.
Bund futures were 22 ticks lower at 143.36. Ten-year German yields were 2 bps higher at 1.50 percent, while two-year yields were flat at 0.059 percent.