EURO GOVT-Bets for healthy auction underpin Spain debt, ECB eyed
* Markets positioned for a healthy Spanish auction
* Bunds in tight ranges before Spanish sale, ECB
* ECB seen holding rates, some expect dovish line from Draghi
LONDON, March 7 (Reuters) - Spanish bond yields inched lower on Thursday as investors bet a debt sale in Madrid would attract healthy demand, while Bunds were in tight ranges, with the European Central Bank expected to keep interest rates steady later in the day.
The ECB is seen holding rates at a record low 0.75 percent and abstaining from any specific action to help Italy as the country struggles to resolve a political stalemate some fear could unsettle financial markets.
Spain's 4 to 5 billion euro sale of paper maturing in 2015, 2018 and 2023 should find decent demand as investors, looking for a return in higher-yielding assets, still find comfort in the support provided by the ECB's promised but untapped bond-buying program.
Political uncertainty in Italy following an inconclusive election has led some investors to favor Spanish debt, narrowing the 10-year yield spread between the two to its tightest since May 2012 this week. That should also provide a favorable backdrop to the auction, analysts said.
"Spanish bonds have performed pretty well and also in the light of what has been happening in Italy, so this market still seems to be rather resilient," Elwin de Groot, senior market economist at Rabobank said.
"I think generally the market is positioned for a pretty decent result in that auction."
Ten-year Spanish government bond yields were 3 basis points lower on the day at 5.00 percent before the sale.
Equivalent Italian yields stood 3.6 bps lower at 4.63 percent, as bond prices rose for a third consecutive day. But they remained well off two-year lows hit at the end of January at 4.075 percent - a sign of lingering political worries.
In particular, there are concerns that instability could return to financial markets if Italian political parties are unable to form a coalition after the Feb. 24-25 vote left no group able to form a government on its own.
"We have seen a bit of a correction but at the same time the yields haven't fallen back to the levels that we saw in January so there is something of a permanent change to some extent in this market," de Groot added.
German Bund futures were down 15 ticks on the day at 144.97, but analysts said there was upside potential if ECB President Mario Draghi was more downbeat on the euro zone's prospects than expected.
The March Bund contract rolls over into the June contract this session and the latter was down 14 ticks on the day at 143.11.
"I still think that Bunds will benefit from a slightly - not dovish Draghi, but one that will exacerbate the negatives ... by expressing his concerns about growth in the euro area," Michael Hewson, senior market analyst at CMC Markets said.
Draghi is also expected to say there is no question of loosening the central bank's rules on bond-buying to accommodate Italy, according to analysts.