* French, Spanish spreads over Germany hit euro-era highs
* Spanish auction sees yields at dangerous levels
* French auction also disappoints, core contagion fears mount
* ECB bond buys seen in small size, adding to euro break-up fears
By Marius Zaharia
LONDON, Nov 17 (Reuters) - The premium of Spanish and French bonds over German Bunds hit fresh euro era highs on Thursday after poor demand at their debt sales raised fears that the euro zone crisis could spiral out of control and potentially lead to a break-up of the bloc.
Spain saw its borrowing costs rising to their highest since 1997, close to the psychologically important level of 7 percent seen by many as a point beyond which selling pressure gathers momentum, eventually pushing the sovereign to seek a bailout.
The sale's outcome received labels ranging from "pretty awful" to "dreadful". Although French results looked better, Paris saw rising yields and dwindling demand as well -- further evidence that the crisis has spread to healthier economies.
"It is another nervous day and certainly not helped by the auctions. The fact that contagion has spread to the core does suggest that markets are more concerned about a break-up," said Philip Shaw, chief economist at Investec.
"What investors are asking is what is the end-game? How can one of the authorities solve the crisis, who is going to do it and so far we have no answers."
The French/German 10-year yield spread rose to 206 basis points for the first time since the launch of the euro, while the equivalent Spanish spread also hit a euro-lifetime high at over 500 bps.
The cost to insure Spanish and French debt against default also hit record highs.
European Central Bank forays in Italian and Spanish debt markets before and after the sales looked to be in modest sizes, traders said, adding to the concerns.
Talk that the ECB should take a greater role in tackling the crisis has intensified in recent days as bond selling pressure spread to countries such as France that used to benefit from safe-haven flows. Paris argues the central bank should intervene more forcefully.
Germany and the ECB itself oppose that view.
"Clearly at the moment the ECB is reluctant to do anything," said Nick Stamenkovic, bond strategist at RIA Capital Markets.
"But if contagion seems to mount and we see a fully-fledged credit crunch in the euro land and a deep recession then I think the ECB needs to do something."
Investec's Shaw said he was getting "increasingly nervous" about his base case scenario that the euro zone will survive.
HITTING THE CORE
ING recommends betting on further flattening of the French 5/10-year yield spread both in outright terms and versus Germany due to tensions in the euro zone. The outright spread was last 96 bps, compared with 110 bps a week ago.
"Our initial target for this trade was 90 bps, but I think it can go further to 80 bps if we continue to have more negative news and no solution," the bank's rate strategist Alessandro Giansanti said.
A narrowing gap between short- and long-term yields as bonds sell off can indicate increased anxiety among investors about being getting their money back.
Giansanti said France and Austria were the weaker triple-A rated sovereigns and he expected their bonds to be better correlated with peripheral debt as long as fears of a euro zone break-up remain in place.
Bunds edged higher, drawing support from the poor auction results and further warnings that banks may be hit by the spreading crisis.
Moody's cut the ratings of 12 German public-sector banks, believing they are likely to receive less federal government support if needed. Fitch said it may lower its stable rating outlook for U.S. banks with large capital markets businesses due to contagion from the euro zone turmoil.
Bund futures last traded 39 ticks up at 138.54.