Italian bond yields are expected to fall from recent record highs in an auction on Thursday in a sign the European Central Bank has managed to ease market pressure, at least for now, with its big injection of longer-term funds earlier this month.

But analysts doubted whether the unprecedented ECB move and domestic progress on reform would be enough to see Italy smoothly over its refinancing hurdles from January to April, when some 91 billion euros (76 billion pounds) of its bonds come due.

And while Rome's short-term funding costs halved at an auction on Wednesday, analysts warned against expecting such a big drop in yields on Thursday.

Wednesday's sale will help sentiment, but should not be viewed as a foretaste of Thursday's auction. There are different dynamics at work, and it is unlikely that borrowing costs will fall as sharply as they did on Wednesday, said Nicholas Spiro, managing director at Spiro Sovereign Strategy.

Italy's six-month borrowing costs tumbled at auction on Wednesday following a similar move in Spanish short-term yields also seen as helped by the ECB liquidity boost, in which European banks took nearly 490 billion euros in cheap three-year loans, easing immediate fears of a credit crunch.

But while Italy can count on strong domestic support such as from retail investors at its short-term debt sales, its longer-dated bonds are more reliant on foreign buyers, giving a clearer picture of the market attitude towards the country's debt.

Italian yields on the secondary market remain close to euro lifetime highs seen as untenable for the euro zone's third-largest economy.

On Thursday, Rome plans to sell up to 8.5 billion euros of bonds, including new tranches of its three- and 10-year benchmarks, in its first long-term debt sale since the ECB three-year funding operation.

The auctions will reopen the November 2014 and March 2022 benchmark BTP bonds. Italy will also offer an April 2018 floating-rate CCTeu bond and an off-the-run September 2021 BTP bond.

The auctions will settle in January, contributing to Italy's gross funding target of around 450 billion euros in 2012.

Given the scale of its funding requirements, there are still big concerns about Italy's ability to get through 2012, Spiro said.

Next quarter is going to be all about Italy.

CAUTION

Markets initially cheered the outcome of Wednesday's auction but caution set back in ahead of Thursday's sale.

Italian 10-year yields closed just above 7 percent on thin volumes, after falling below this closely watched threshold earlier in the session.

The three-year benchmark bond Italy plans to reopen on Thursday yielded around 5.7 percent at Wednesday's close.

Both yields are below the levels seen at the auctions at the end of November, when Rome paid 7.56 percent on 10-year paper and an even higher 7.89 percent yield on three-year debt.

The higher cost of borrowing on a shorter-term maturity compared to the longer-term one at that time was a sign of acute market stress.

(At the end of November) the mix of indecisive action from EU policymakers, a deteriorating economic climate and tortuous progress on the reform front in Italy was fuelling an increasingly negative outlook on its short-term debt sustainability, said Raj Badiani at IHS Global Insight.

In a push to regain market confidence, Italy's parliament gave final approval ahead of Christmas to an emergency austerity budget rushed through by a new technocrat government.

After underlining the goal of a balanced budget in 2013 with Italy's third austerity package since the summer, Prime Minister Mario Monti has promised to tackle Italy's chronically low growth through long-delayed liberalisations and labour market reforms.

Italy's economy is set to shrink next year, highlighting the need for growth-enhancing reform, and analysts warn that markets are likely to keep the government under intense pressure.

(Reporting by Valentina Za)