EURO GOVT-Spanish yields fall after strong debt sale
* Investors expect Cyprus to come up with new plan
* Spain sells more than planned at debt auction
* Bunds steady, Italian and Spanish yields fall
By Marius Zaharia
LONDON, March 21 (Reuters) - Spanish government bond yields fell on Thursday after Madrid showed resilience to the Cypriot crisis at a strongly bid debt auction in which it sold more bonds than planned.
Demand for debt issued by vulnerable states such as Spain remains underpinned by the belief that the European Central Bank would step in with support if they came under pressure.
Bunds weakened slightly, with expectations Cyprus will come up with a new plan to resolve the impasse over its proposed bailout making investors reluctant to increase allocations to low-risk assets.
But German yields were expected to hold close to 2013 lows in the near term as uncertainty over the fate of Cyprus remained high, keeping alive fears of contagion in the euro zone.
The Mediterranean island was in talks with Russia over potential cooperation in the banking and energy sectors and over a loan aimed at avoiding a levy on bank deposits proposed by the European Union as part of a bailout.
Cyprus ordered banks to stay shut until next week to prevent a bank run. The ECB said it would maintain its emergency liquidity assistance for Cypriot banks until March 25, which is now seen as a deadline for a plan to be agreed.
"The market now believes that there will be something formulated, that a solution will be brought forward," ICAP strategist Philip Tyson said. "It could be a different matter next week, though."
Spanish 10-year yields were 11 basis points lower on the day at 4.89 percent, levels seen before the Cypriot bailout plan was announced.
The drop in yields accelerated following an auction in which Spain sold 4.5 billion euros worth of 2015, 2018 and 2023 bonds, more than the 3-4 billion euro target. Borrowing costs fell and analysts said demand levels looked strong.
"All lines were well received despite the recent turmoil ... market dealers probably hope that the Cyprus bailout will be sorted out soon," said Annalisa Piazza, market economist at Newedge in London.
Bayerische Landesbank rate strategist Norbert Wuthe said the Cyprus situation was "a litmus test" of confidence in the ECB's as yet unused bond-buying programme. The so far "tame market reaction contrasting the shockwaves from the media" showed the backstop was working, he said.
"A BIT SCARY"
Bund futures were last 8 ticks lower on the day at 144.22, while 10-year cash yields rose 0.7 basis points to 1.385 percent, having hit a 2013 low of 1.343 percent on Tuesday.
One trader said a range between 144.00 and this week's high of 144.82 should hold near-term. However, he warned against underestimating the seriousness of the situation, pointing to this week's gains in the Bund future of more than a full point.
"It feels the market wants to buy (Bunds after any dip in prices). Nobody wants to be caught short but they don't want to be caught too long either," the trader said.
"The market seems to be very nervous. Cyprus is indeed a small economy ... but when you see it managed to move the market that much it's a bit scary."
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