EURO GOVT-Spanish yields rise as markets brace for testing sale
* Political uncertainty to dent demand at Spanish sale
* Failure to sell maximum amount would disappoint-analyst
* ECB meeting keeps Bunds range-bound
By Ana Nicolaci da Costa
LONDON, Feb 7 (Reuters) - Spanish government bond yields rose on Thursday as investors braced for an auction, while a potentially testing European Central Bank meeting kept German Bunds range-bound.
Political uncertainty after Prime Minister Mariano Rajoy faced calls to resign over a corruption scandal this week may dampen investor appetite at the sale, as the country's economic outlook remains bleak.
The ECB is later expected to keep interest rates unchanged at 0.75 percent but its president, Mario Draghi, faces a grilling over the bank's sensitivity to the euro's sharp rise and his connection to an Italian banking scandal which has also unsettled Italian debt markets.
Ten-year Spanish government bond yields were 3.7 basis points higher at 5.48 percent, while two-year borrowing costs rose 1.9 bps to 2.89 percent.
Spain's Treasury aims to issue between 3.5 billion euros and 4.5 billion euros when it sells bonds maturing in 2015, 2018 and 2029.
Marc Ostwald, strategist at Monument Securities, said a failure by Spain's Treasury to issue the maximum amount would be disappointing.
The ECB was more optimistic than expected on the region's economic prospects at its last meeting, and investors will look to see whether it keeps that tone or sounds more cautious.
"Maybe the danger is we go into the meeting and people are hopeful that he takes a more dovish slant than he did in January and maybe there is some room for disappointment - I suppose that's the danger going in," one trader said.
In particular, investors will be watching Draghi's assessment of the initial repayments of long-term loans or LTROs.
While they are considered a sign of a healing banking sector, they have also led to a spike in bank-to-banking lending costs which many view as de facto monetary tightening.
The upcoming events kept investors on the sidelines and German Bund futures in a tight ranges. Bunds were down 6 ticks on the day at 142.48.
"Key will be the slant the ECB puts - if it does put any at all - on the recent, very pronounced bout of positivism (after) the LTRO repayment which has served to push up short-dated interest rates and significantly strengthen the euro," Richard McGuire, senior fixed income strategist, at Rabobank said.
Investors will look to see "whether the ECB believes this to be a justified reaction to a more positive outlook for the banking sector and the region at large or whether it's perhaps too much too soon and therefore risks dampening any possible incipient recovery."
An endorsement would leave higher-rated paper vulnerable to selling while any concerns raised would support them, he said.