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UPDATE 1-Spanish borrowing costs fall on rescue hopes

* Treasury sells at top end of target

* Yields fall on two of three bonds as investors await Spain rescue call

* Demand strong on all three bonds (Adds details, comment)

MADRID, Oct 4 (Reuters) - Spanish two-and five-year bond yields fell sharply at an auction on Thursday on expectations the country will soon seek European aid to cut its debt costs.

The yield on the 2014 bond was 3.282 percent after 5.204 percent when it was last sold on July 19. The 2017 bond sold at an average yield of 4.766 percent, compared with 6.459 percent the last time it was sold on the same date in July.

The 2015 bond yield edged up to 3.956 percent, however, compared with 3.845 percent when it was last sold on Sept. 20, indicating lingering concern over when Spain would ask for help.

The Treasury managed to meet the top end of its 3 billion to 4 billion euro ($3.87-5.16 billion) target for the auction, showing investors still have appetite for the country's debt in the belief a rescue package would come soon.

Indeed, demand for each of the bonds rose from the last time they were sold.

Spain's debt costs spiralled higher in July but have eased since the European Central Bank unveiled a plan to help out struggling euro zone states by buying their debt.

Continued expectation that Spain will ask for a rescue and trigger the ECB bond-buying programme helped yields stay low in the first test of Spanish debt since the country presented a tough budget for 2013 last week.

"The only bad thing is that the yields are a little higher than expected," said Nicolas Lopez, head of analysis at M&G Valores. "It's true that the market has doubts over the timing of Spain rescue call," he added.

Spain remains at the centre of investor concerns in the euro crisis, fearful its deficit cutting targets will be impossible to meet as the country slides into a deep recession.

Analysts say that relief may not last forever, and say the country is being given the benefit of the doubt because they expect it to call for a rescue soon.

The auction puts the country's planned issuance for the year further ahead of schedule, having now issued around 86 percent of medium and long-term bonds it envisaged.

On the secondary market, the spread between Spain's benchmark 10-year bond and the German benchmark, which measures the perceived risk of investing in Spain, widened by 10 basis points to 446 basis points compared with Wednesday's close. ($1 = 0.7751 euros)

(Additional reporting by Manolo Ruiz; Writing by Nigel Davies; Editing by Fiona Ortiz and Julien Toyer)

((nigel.davies@thomsonreuters.com)(+34 91 585 2158)(Reuters Messaging: nigel.davies.thomsonreuters@reuters.net))

Keywords: SPAIN DEBT/