* Spanish auction falls short of maximum issuance target * Auction spooks market, Spain sells off while Bunds rally * German sale solid, demand for high-quality bonds intact By William James LONDON, Dec 5 (Reuters) - Spanish bond yields rose sharply on Wednesday after demand at its latest bond sale disappointed expectations, causing a shift towards less risky assets that helped push German Bund futures higher. A strong auction had been anticipated, but the 4.25 billion euros raised fell short of the 4.5 billion euro maximum target, with analysts pointing to the wide range of accepted bids as a sign of weaker overall demand. The sale triggered a swift selloff in Spanish debt, driving 10-year bond yields 12 basis points higher to 5.39 percent while German debt futures rallied to a session high of 143.05, 31 ticks up on the day. "This has generally been perceived as a negative result by the market," said Rabobank strategist Lyn Graham-Taylor. The auction brought recent gains in peripheral bonds to a halt, although the reversal took back only a small portion of a rally that pushed yields to their lowest since March on Monday. "It's a bit disappointing that they didn't manage to raise the full amount... that caused a bit of a correction in the market," said Nick Stamenkovic, strategist at RIA Capital Markets in Edinburgh. "But the yields are still down from the previous auction and demand is still pretty decent out there." The market's earlier 'risk-on' mood this week was fuelled by the announcement of better-than-expected terms on a Greek bond buyback, increasing the chances of a successful debt reduction and the payment of badly-needed aid to Athens. That deal was expected to be concluded on Friday and, providing it was successful, the improved appetite for higher-yielding assets could resume into year end, analysts said. CORE SUPPORT In contrast to events in Madrid, a sale of two-year German bonds was sufficiently well bid to keep auction yields below zero as investors paid up for the security and liquidity of assets issued by the euro zone's strongest sovereign. "The auction was good. It's the last auction for this year so they ended the programme pretty well," said Artis Frankovics, strategist at Nomura in London. "Fundamentals haven't changed for the Schatz. There's still demand for high quality collateral." The weak Spanish sale just before the Schatz auction helped demand but the underlying desire to hold German paper remain strong, supported by longer-term worries about the euro zone and more immediate concerns about the progress of U.S budget talks. Policymakers across party lines in the United States are trying to hammer out a deal to avoid a series of tax rises and spending cuts which would hamper a nascent economic recovery. "If they don't resolve this 'fiscal cliff', we've got this dread of their economy going back into recession which will have a real detrimental effect for the world," said Alan McQuaid, chief economist at Merrion Stockbrokers. "If it's resolved I think safe havens will sell off a bit and then we come back next year... but the market will still be nervous with elections in Italy and Germany coming up (in 2013)." Focus will now shift to U.S. data, with ADP employment figures guiding expectations for Friday's headline non-farm payrolls report which is used as a key indicator of the U.S. economy's health.