TREASURIES-Prices drop on U.S., Europe hopes; auction lukewarm

* Three-year note auction sees record low yields

* German ZEW sentiment index rises sharply for December

* Fed expected to announce more Treasuries buying on Weds

NEW YORK, Dec 11 (Reuters) - U.S. Treasuries fell on Tuesday as investors saw signs of hope in budget talks in Washington and in the German economy, ahead of expected easing from the Federal Reserve after a two-day meeting ends on Wednesday. Treasuries held early losses after a three-year note auction saw lukewarm bidding, as a record low yield perhaps deterred some potential buyers. The U.S. Treasury sold $32 billion of three-year notes at a high yield of 0.327 percent, with a below-average bid-to-cover ratio of 3.36. "Obviously it was on the rich side, and I think that probably contributed to some of the fairly lackluster bidding," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco. Benchmark 10-year Treasury notes were trading 11/32 lower in price to yield 1.656 percent after the auction, the highest in over two weeks. Thirty-year bonds were 30/32 lower in price to yield 2.844 percent, the highest in more than a month, from 2.80 percent on Monday. Investors were instead looking to riskier assets such as stocks, partly on an unexpectedly strong reading on German investor sentiment. Germany's ZEW economic sentiment index jumped to 6.9 in December, far higher than the -12.0 forecast and the previous reading of -15.7. Italian markets, jittery on Monday after Prime Minister Mario Monti's decision to step down early, also proved calmer on Tuesday. Investors' willingness to take on more risk was supported as well by reports of a pick-up in the pace of talks to avert the U.S. "fiscal cliff" of steep tax hikes and spending cuts set for the new year, although Republicans and Democrats remain far apart. Still, investors this week will focus on Wednesday's conclusion to the Federal Reserve's two-day policy meeting, which is widely expected to produce another bond buying program. A new program could take effect once the current Operation Twist stimulus program finishes at month-end, Nomura analysts wrote. "We expect additional purchases of Treasuries to match the size and pace of notional purchases ($45 billion/month) of Operation Twist," they wrote. Half the respondents in a Reuters poll on Friday said they too expected $45 billion per month in buying through a new round of Treasury securities purchases. In addition, the Treasury will sell $21 billion in 10-year notes on Wednesday and $13 billion in 30-year bonds on Thursday. Traders typically will push for lower Treasury prices heading into such auctions.