* German bond auction finds weak demand due to low yields * Profit-taking drives Spanish yields away from 6 pct level * Thursday's Italian BTP sale in focus after bill yields rise By William James LONDON, April 11 (Reuters) - Bund futures fell on Wednesday as record low auction yields for Germany's new 10-year bond illustrated the limits of investor appetite for ultra-low yielding debt but concerns about Spain were likely to limit the selloff. Although Spanish bond prices rebounded after Tuesday's sharp fall, doubts persisted over whether Madrid can exercise the fiscal discipline needed to control public finances amid a faltering global growth outlook. "The sentiment remains weak. Today may be a day where core fixed income needs to sell off and that's putting a little bid back into the peripherals... but I still think we can see those markets move wider in the near term," a trader said. The threat of a fresh flare-up in the sovereign debt crisis meant investors were still willing to buy 3.87 billion euros despite the ultra-low yield, but the lower-than-usual demand which failed to meet the amount on offer showed prices have risen to unappealing levels. "Auctions are always a good test of where the market is really at and this auction is telling us that Bunds are a bit toppy, which I think they are," said Padhraic Garvey, strategist at ING in Amsterdam. The Bund future slid to a low of 139.54, down 76 ticks on the day and was last at 139.67. Spanish 10-year yields fell 9 basis points to 5.89 percent, backing away from the test of 6 percent in the previous session that had taken yields to a four-month high. However, traders said much of this was driven by buying to close out profitable short-term positions that had benefited from the recent fall in prices. "At 6 percent or 5.75 percent the yield signals that the market isn't really confident - this is rather a pause than a turnaround," said Michael Leister, strategist at DZ Bank. Spanish industrial output data showing a larger-than-expected drop in February underscored the dilemma facing the government as it tries to generate economic growth while still implementing deficit-cutting austerity plans. SUPPLY DYNAMICS German 10-year yields rose 7 basis point to 1.71 percent, climbing away from the record low of 1.637 percent that was matched in the previous session. The country's debt sale failed to draw bids worth the full amount on offer, though the result was not as poor as that seen last November when the previous Bund was launched. With investors still on edge and little in the way of economic data to digest, supply will remain the driving factor for markets this week, market participants said. After a mixed T-bill sale earlier in the day, Italy's auction of up to 5 billion euros of BTP bonds on Thursday could be the catalyst for a fresh rise in yields as dealers sell existing debt to make room for the new issue. Italian debt has suffered alongside Spanish paper in recent sessions on fears that serious funding problems for Spain would spill over into the euro zone's other highly-indebted economies. The 10-year Italian yield was down 17 basis points on the day at 5.52 percent, but with few long-term accounts looking to take long positions, traders said the scope for large gains ahead of the auction was limited.