* Spanish debt auction expected to go smoothly
* ECB seen keeping rates steady at record lows
* Bunds steady
By Marius Zaharia
LONDON, Jan 10 (Reuters) - Spanish government bond yields inched higher on Thursday as cash-hungry Madrid kicks off a tricky 2013 funding programme with a debt sale for which it cautiously picked short-term maturities.
German Bunds were steady before a European Central Bank meeting where key interest rates are expected to remain unchanged at record lows.
Spain plans to issue 4-5 billion euros of mainly two-year debt, which 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.
The backstop of potential ECB purchases and an improvement in appetite for high-yielding assets after the United States averted a fiscal crisis earlier this year are expected to support bidding at the auction.
However, the fact that Spain decided to start the most challenging funding programme in the euro zone with a new bond carrying the shortest possible maturity raises questions about its own confidence in its chances of avoiding a bailout.
“The auction will go well ... demand will be there because it falls within the range of the OMT programme and the (two-year) bond is protected from a steep decline,” said Mathias van der Jeugt, rate strategist at KBC.
“They could have tried a longer one but they wanted to be cautious and start the funding programme with a solid sale. Demand at auctions will be a key variable (in gauging whether a bailout is needed or not).”
The other bonds on offer are old 2018 and 2026 lines, which are of less interest to investors as re-openings are usually in small size and respond to specific dealer demand.
With some investors making room in their books for the new debt, yields were slightly higher across the Spanish curve.
The 10-year was 2.5 basis points up at 5.165 percent, having been relatively steady since the start of the year after falling from just under 7.8 percent in July 2012, before the ECB first signalled its OMT plans.
The ECB is expected to keep its key refinancing rate unchanged at a record low of 0.75 percent and its deposit facility rate at zero percent as the euro zone economy has shown some signs of stabilising recently.
However, investors will be looking for any clues from President Mario Draghi on the likelihood of future rate cuts. In December, he said the ECB had discussed a deposit rate cut, sending two-year German yields in negative territory.
“Yields have moved higher since the lows in December, there’s been less safe-haven bids and more of a positive tone. So the market would be surprised if he would be bearish,” Investec fixed income strategist Elisabeth Afseth said.
A pessimistic assessment of the euro zone economy from Draghi may push Bunds higher, but the most likely scenario is a cautiously upbeat tone from Draghi.
“The ECB might be a bit more upbeat so chances of a rate cut might recede. You could argue it’s a negative (for Bunds) but I‘m not convinced. It’s all about future data,” the trader said.
Bund futures were up 3 ticks at 143.61. Ten-year German yields were steady at 1.48 percent, while two-year yields were 0.4 bps lower at 0.055 percent.