* French, Spanish spreads over Germany hit euro-era highs * Spanish auction sees yields at dangerous levels * ECB bond purchases take Italian, Spanish yields off highs By Marius Zaharia and Ana Nicolaci da Costa LONDON, Nov 17 (Reuters) - The premium of Spanish over German Bunds hit fresh euro era highs on Thursday after poor demand at a Spanish debt sale raised fears that the euro zone crisis could spiral out of control and potentially lead to a break-up of the bloc. Spain saw its borrowing costs rise to their highest since it joined the euro, close to the psychologically important level of 7 percent seen by many as a point beyond which funding becomes unsustainable. Ten-year Spanish government bond yields had come off their highs by late trade and Italian yields turned lower as the ECB intervened and Italy's new prime minister pledged additional economic reforms. But signs that contagion is spreading to the so-called core Europe -- French premiums over German Bunds also hit a euro-era high -- are increasing pressure on policymakers to ramp up action to tackle the crisis. "It is another nervous day and certainly not helped by the auctions. The fact that contagion has spread to the core does suggest that markets are more concerned about a break-up," said Philip Shaw, chief economist at Investec. "What investors are asking is what is the end-game? How can one of the authorities solve the crisis, who is going to do it and so far we have no answers." The Spanish/German 10-year yield spread hit its highest level since the launch of the euro above 500 basis points after Spain payed a high rate to sell its 10-year debt ahead of a parliamentary election on Sunday. Ten-year Spanish government bond yields rose as far as 6.82 percent before retracing to 6.5 percent in late trade, still up on the day. "(It was a) very poor Spanish auction which will heighten concerns the door to Spain being able to sustainably finance itself is closing," Richard McGuire, strategist at Rabobank said. "This, in turn, stands to further expedite the convergence of Spanish yields with those of Italy as the country plays catch-up with its more troubled peer. Most troublesome, though, is the hugely elevated yield necessary to ensure even this lacklustre outcome." The 10-yr Italian government bond yield premium over the Spanish equivalent fell to its tightest in two months and further tightening was expected before the elections. "This may well underpin the negative news flow in respect to the situation of the peripheral government bond markets," Commerzbank strategist David Schnautz said. Ten-year Italian government bond yields were at 6.9 percent, off the day's high of 7.3 percent but still near levels considered unsustainable. "There has been very aggressive ECB buying since lunch," said one trader. New Italian Prime Minister Mario Monti on Thursday promised rigour and fairness in painful reforms to dig the country out of a financial crisis. CORE EUROPE The French/German 10-year yield spread rose to 206 basis points for the first time since the launch of the euro before falling back to 177 basis points in late trade, with one trader citing short covering. An auction of French debt saw France's cost of borrowing over two and four years jump by around half a percentage point, reflecting growing concerns it may be dragged into the euro zone's sovereign debt crisis. Calls for the ECB to take a greater role in tackling the crisis has intensified in recent days as bond selling pressure spread to countries such as France that used to benefit from safe-haven flows. Paris argues the central bank should intervene more forcefully. Germany and the ECB itself oppose that view. "Clearly at the moment the ECB is reluctant to do anything," said Nick Stamenkovic, bond strategist at RIA Capital Markets. "But if contagion seems to mount and we see a fully fledged credit crunch in euroland and a deep recession then I think the ECB needs to do something." German government bonds have benefited from the recent bout of worries but an improvement in U.S. data gave market participants an opportunity to take profit, with the German Bund future settling down 83 ticks on the day at 137.32. New claims for U.S. jobless benefits hit a seven-month low last week and permits for future home construction rebounded in October, the latest data to suggest the economy was gaining traction.