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Italy bond sale set to be show of nerves

By Francesca Landini

MILAN, Oct 11 (Reuters) - Italy will pay slightly more than a month ago to borrow over three years at a bond auction on Thursday, a sign of renewed doubts over the euro zone's ability to end its debt crisis due to Spain's dithering over aid.

Italy's cost of borrowing over three years has sunk from peaks around 5.3 percent in June and it has already found 80 percent of the 460-465 billion euros it has to borrow this year to finance a debt that is more than 120 percent of national output.

But the offer of up to 6 billion euros ($7.74 billion) of three-year paper and off the run bonds with maturities of up to 13 years follows a sale of 11 billion of shorter-term debt that saw yields rise 25 basis points on Wednesday.

Worries over whether Italy and Spain can avoid fiscal collapses that could down the euro have crept back into investors' minds in the month since the European Central Bank laid out a decisive plan to buy the bonds of struggling governments.

Spain is holding off making the formal request for aid that would trigger ECB action and there are little signs of pressure from other euro zone governments for it to get on with it. That contrasts with the message of encouragement sent by ECB chief Mario Draghi last week, however, and expectations the bank will act sooner or later are keeping a lid on Italian yields.

"Yields on three-year bonds could rise perhaps a tad but nothing dramatic, given the relatively favourable European Central Bank-driven backdrop for Spanish and Italian paper," said Nicholas Spiro, director at Spiro Sovereign Strategy.

"What concerns us most is that sentiment remains sufficiently fragile for the recent differentiation between Italy and Spain to wane."

Having sold a new 15-year bond in mid-September, tapping a segment of the yield curve where demand is volatile, the Treasury will play it safer on Thursday by offering only long-dated notes that have been requested by specialist banks.

Rome will offer between 1.5 and 2.25 billion euros by reopening four-, six- and 13-year bonds that it no longer issues on a regular basis.

Coupon and bond repayments worth roughly 19 billion euros will also help the sale. Its last auction of 3-year paper a month ago saw yields of 2.75 percent.

The Treasury will come back to market next week with a new tranche of its four-year, Italian inflation-linked BTP Italia.

It sold a hefty 7.3 billion euros of similar linker bonds to retail buyers in March, but a second sale in June raised just 1.7 billion euros as seasonal tax payments hit demand.

Rome has carefully studied the timing for this special offer and aims to capture heavy retail investors' demand and reach an updated borrowing target for this year.

The head of the debt management office told Reuters on Tuesday that the Treasury had raised its gross funding target for 2012 to 460-465 billion euros from a previous forecast of 440-450 billion euros. ($1 = 0.7751 euros)

(Additional reporting Alessia Pe, Elvira Pollina and Giulio Piovaccari in Milan; editing by Patrick Graham)

((francesca.landini@thomsonreuters.com)(+39 02 66129437)(Reuters Messaging: reutersitaly.thomsonreuters@reuters.net))

Keywords: ITALY DEBT/