Spain 10-year bond cost to ease despite bailout hesitancy

* Spain aims to sell 3.5-4.5 bln euros in two bonds
* Yield on 10-year bond to fall, but hold at high levels
* Treasury will also sell a new three-year bond
* Analyst says Spain's fiscal credibility would be better
under rescue package

By Nigel Davies
MADRID, Sept 20 (Reuters) - Spain's 10-year borrowing costs
are likely to fall sharply at an auction on Thursday compared
with a month ago but remain uncomfortably high as Prime Minister
Mariano Rajoy holds back from requesting a rescue that many
regard as inevitable.
Just two days after selling 4.6 billion euros ($6 billion)
of short-dated debt, the Treasury will test demand for Spanish
risk in the tougher 10-year maturity and sell a new three-year
bond, aiming to raise 4.5 billion euros in total.
The yield on the benchmark 2022 bond is seen falling to
around 5.75 percent according to analysts, close to its lowest
level in four months, and down from 6.65 percent when it was
last sold on Aug. 2. The new 2015 bond was quoted at around 3.9
percent in the grey market on Wednesday, an indication of where
it is likely to sell.
But recent relief from market pressure may not last if
Madrid fails to make the request for an international package
that would allow the European Central Bank to buy its bonds and
keep its funding costs at affordable levels.
Spain is at the heart of the euro zone debt crisis, now in
its third year, with investors concerned it will not be able to
bring down its massive public deficit and control its soaring
debt in the midst of a harsh and prolonged recession.
As well as reassuring investors it will be able to meet
repayments on its debt, a bailout would mean fiscal targets the
country has consistently missed in recent years are subjected to
more rigorous control, analysts say.
"The auction should not be a problem for Spain. But markets
want to see more credibility to Spain's fiscal targets, which
could be better assured under a rescue package, and ease the
threat of losing its investment grade (credit ratings)," said
Orlando Green, strategist at Credit Agricole.
Spain is rated Baa3 by Moody's, which is due to complete a
review in September. Rival Standard & Poor's said on Wednesday
it was unlikely to cut Spain's rating below investment grade in
the near future given the lifeline promised by the ECB's new
bond-buying programme.
Green said the bulk of demand at Thursday's auction is
likely to be for the shorter-dated bond, which would be eligible
for purchase by the ECB if Spain asks for a rescue.

Spain has managed to complete around 80 percent of its
medium- and long-term borrowing plan for this year, but faces a
refinancing hump of 27.5 billion euros in October.
It has increasingly depended on domestic banks to buy its
debt at auctions, however, a reliance that would be reduced if
it sought a rescue package.
Spain has already requested 100 billion euros of aid for its
banks, crippled when a massive property bubble burst, but Rajoy
has said he will not sign up for a full-scale bailout that would
impose further tough budget conditions. His government has
already committed to austerity measures worth 10 percent of
gross domestic product up to the end of 2014 and believes more
would lead to a public backlash.
But a fresh spike in yields, more calls for cash from
indebted regional governments or problems hitting this year's
EU-agreed deficit targets could all push Spain into seeking ECB
and European aid despite its hesitancy over the conditions.
ECB Governing Council member Luc Coene warned Rajoy on
Monday not to delay triggering the programme, which would
involve requesting aid from the euro zone's new ESM bailout
fund, and risk another rapid rise in yields.