European banks Thursday bid up a €4.074 billion or $5.32 billion of medium-term Spanish sovereign bonds, driving down the amount of interest needs to pay investors on three-year bonds.

Madrid, which was able to meet more than one-third of its financing goals for the year with the auction, sold three bond tranches, with a €2.27 billion ($2.96 billion) section of three-year bonds paying an average yield of 3.332 percent, lower than the 3.448 percent yield similar bonds were paying in the open market prior to the auction.

But even that positive result was mixed, as the current 3.332 percent yield is still higher than the the 2.861 percent Spain was able to offer on similar three-year bonds at the beginning of February. More notably, the spread between the benchmark 10-year Spanish notes and German bunds, considered the gold-standard safe-haven investment among European sovereigns, grew.

The Spanish government said the results of the bond auction were a victory for the country's treasuries, with Luis de Guindos, the economy minister, telling Parliament on Thursday that the high demand during the auction was an important sign of confidence in the Spanish economy and the measures being adopted.

The diverging dynamics between the price movements of the three-year bonds placed Thursday and those for benchmark bonds in the open market suggests the European Central Bank's policy of offering banks large amounts of short- and medium-term euro loans at ultra-low rates is encouraging the banks to buy up sovereign debt, even as concern over the future is keeping interest in longer-term debt at bay.

Even though the rally is showing signs of fading, there's still a qualitatively different set of dynamics at work now compared to late last year, Nicholas Spiro, Managing Director at Spiro Sovereign Strategy, told The Wall Street Journal adding that the ECB's three-year liquidity has erected a psychological firewall around Spanish and Italian debt.

Adding to the equation is that fact that Spain's credit rating was downgraded by U.S.-based rating agency Moody's earlier in the week, citing concern about the Spanish macroeconomic picture that was confirmed with statistics from the European Union showing that economy contracted 0.3 percent in the fourth quarter.

Jo Tomkins, a strategist at 4Cast, told Reuters the auction reflected the effects of austerity and ambitious deficit targets, it's just a reflection of the general fear that's in the market.