Spain will provide 2012's first real test of demand for debt from the euro zone's bruised periphery on Thursday when it sells around 5 billion euros ($6.39 billion) of bonds.

Italy will also venture into markets with a short-term debt sale before embarking on this year's massive campaign of bond issuance at an auction on Friday.

The two countries are among weaker euro zone states scrambling to convince markets they can slash their deficits while somehow also stimulating growth and creating jobs and are seen as especially vulnerable should the debt crisis escalate.

Spain's Treasury will auction a new three-year benchmark bond and reopen two bonds each maturing in 2016, in a sale that is expected to attract substantial support from domestic banks flush with European Central Bank cash.

The massive size of the three-year lending from the ECB reinforces the view that auctions should be supported by domestic investors, said BNP Paribas strategist Ioannis Sokos.

That will be the case for a few more weeks until, or if, we see more resolute action on the crisis at a political level.

Both Spain and Italy saw their short-term funding costs halve in December after banks that borrowed nearly 500 million euros from the ECB at its unprecedented offer of three-year funding used the ultra-cheap loans to buy higher-yielding debt.

Spain's borrowing costs will remain high, however, despite a rally in periphery debt on Wednesday that eased concerns about its funding.

The premium investors charge to hold the country's 10-year bond rather than its safe-haven German equivalent fell to around 355 basis points, a week low, after an official at rating agency said it did not expect to cut France from triple-A this year.

We've seen a small but steady spread tightening, particularly in Spain, and it looks like the locals are supporting the market. We're not seeing the same in Italy, however, and Spain is outperforming quite significantly, said Peter Schaffrik, rate strategist at RBC Capital Markets.

The new three-year bond was around 3.65 percent in the grey market on Wednesday, giving some guidance to where the average yield is likely be on Thursday, although the yield may yet rise in pre-auction trading.

The April 2016 bond - last sold in July - was yielding around 4.0 percent. Spain's October 2016 bond, also to be reopened on Thursday, was yielding around 4.45 percent, slightly less than the 4.848 percent at which it was last sold on November 3.

On Wednesday the Treasury said it planned to cut net debt issuance by 26 percent in 2012, although those plans could change with a new budget in March.


A Treasury bill sale will meanwhile give Italy a first taste of investors sentiment before it auctions up to 4.75 billion euros of bonds on Friday.

Rome is scheduled to sell 8.5 billion euros in 12-month BOT bills and 3.5 billion euros of bills maturing at the end of May.

The January 2013 BOT bill on offer on Thursday was trading at around 3.5 percent in the grey market on Wednesday, a sharply lower yield compared with the near 6 percent rate Italy paid to sell one-year paper in mid-December.

Since the ECB flooded the market with extra liquidity most demand has been seen at the front-end, so this means the sales will likely be well supported on Thursday, said an analyst at a major euro zone bank.

Italy must refinance more than 90 billion euros of longer-term bonds falling due between February and April, and with no end in sight to the European debt crisis, its bonds remain under intense pressure, with yields at levels viewed as unsustainable.

($1 = 0.7826 euros)

(Additional reporting by Valentina Za in Milan and Kirsten Donovan in London; Editing by Catherine Evans)