* Sells 8.5 bln eur in 6-mth bills, bid/cover up from March
* Yield up 65 bps from March to 1.77 pct, highest since Jan
* Markets eyeing 3.75-6.25 bln eur Italy bond sale on Fri
By Valentina Za
MILAN, April 26 (Reuters) - Italy paid the highest yield since January to sell six-month bills on Thursday as concerns about feeble economies and large debt burdens in the euro zone put renewed pressure on the borrowing costs of its weaker states.
The average rate on Thursday rose to 1.77 percent from 1.12 percent at a bill auction held a month ago, before a more challenging long-term debt sale on Friday where the euro bloc's third biggest economy is again likely to have to pay higher yields than last time, in March.
The Treasury sold the planned 8.5 billion euros in bills, with bids totalling 1.7 times the amount on offer, up from 1.5 times at a similar-sized sale a month ago.
"The auction went well. The yield, though higher than in March, is below market levels seen this morning and in recent sessions," said UniCredit strategist Luca Cazzulani.
A flood of cheap European Central Bank funds helped push down Italian borrowing costs earlier this year. Six-month auction yields had been declining since hitting a euro lifetime record of 6.5 percent in late November and reached an 18-month low in March.
But budget and banking troubles in Spain have hurt market confidence in the euro zone's peripheral economies, reversing the fall in yields, as investors worry that economic recession will hamper efforts to cut budget deficits.
Next week's elections in France, Greece and, further ahead, the Netherlands also adds to market uncertainty.
Weaker-than-expected euro zone sentiment data weighed on European stock and bond markets, pushing Italian and Spanish bond yields higher after the sale.
Short-term Treasury bills traditionally attract steady demand from Italian buyers, including retail investors. Some 9 billion euros of bills are maturing on April 30, feeding into reinvestment flows.
But Rome also needs foreign demand to be able to refinance its 1.9 trillion euro debt, the world's fourth-largest. Deputy Economy Minister Vittorio Grilli visits China on Thursday seeking to promote investments in Italian assets, including government bonds.
Italy faces challenging funding conditions at sales of longer-term debt.
"The outcome of tomorrow's auction will be more interesting to watch: the size is not small but I expect demand to be there, thanks to domestic investors," said ING strategist Alessandro Giansanti.
The Treasury will offer up to 6.25 billion euros in bonds on Friday, including five- and 10-year debt.
Support from domestic banks has helped Italy push auctions through, even when spiralling concerns last November threatened to tip the country into a Greek-style debt crisis.
Citi analysts said the Treasury hedged against risks of weak demand at Friday's bond sale by widening the range between the bottom and top amount on offer - and setting the former at just 3.75 billion euros, the lowest level this year.