EURO GOVT-German yields rise after Draghi backs off rate cuts
* German Schatz yield hits highest in nearly three months
* ECB seen backing away from near-term interest rate cut
* Spanish bond auction sparks core debt selloff
* Spanish 10-year yield dips to 10-month low below 5 percent
By William James and Marius Zaharia
LONDON, Jan 10 (Reuters) - Yields on German bonds rose on Thursday after the European Central Bank left interest rates on hold and signalled pressure for a cut from some of the bank's policymakers had eased.
ECB President Mario Draghi, speaking at the bank's monthly news conference, said the decision to leave interest rates at 0.75 percent was unanimous.
This contrasted with last month's signal that the ECB was divided on whether to cut, and caused investors to quickly price out lingering expectations of a near-term fall in the central bank's main interest rate.
"The ECB's evident reticence to either cut interest rates or, more importantly, signal any possibility of future interest rate reduction has added to the pressure on core curves," said Rabobank strategist Richard McGuire.
German two-year bond yields, which are particularly sensitive to interest rate expectations due to their short duration, rose 4 basis points on the day to 0.107 percent, their highest since late October.
Short-term money market rates also moved quickly to reflect the changing outlook with Euribor futures selling off and Eonia overnight rates rising to reflect higher interbank borrowing costs.
Bund futures extended an earlier fall to hit a low of 142.54 before recovering some ground to settle at 142.70, down 88 ticks on the day.
Demand for longer-term, low-risk German debt had started falling earlier in the day after struggling euro zone sovereign Spain beat its own estimates at its first bond auction of the year by issuing more debt than it had initially targeted.
That calmed the markets' worst fears over how Madrid will meet it tough 2013 fundraising target and helped push the country's 10-year bond yield below the closely-watched 5 percent level for the first time in 10 months.
"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."
Spanish 10-year yields were last 22 bps lower on the day at 4.92 percent, on track for their second biggest daily fall in nearly three months. Equivalent Italian yields also rallied, driving yields 11 bps lower to 4.17 percent.
While the market responded well to the auction results, concerns remain about Spain's ability to complete the most challenging funding programme in the euro zone this year.
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.