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UPDATE 2-Spain kicks off tough 2013 with strong bond sale

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* Raises above-target 5.8 bln eur at lower yields

* Foreign buyers focus on 2026 bond, says market maker

* Benchmark 10-year Spanish bond yield dips back below 5 pct

By Manuel María Ruiz

MADRID, Jan 10 (Reuters) - Recession-hit Spain kicked off a tough 2013 funding programme on Thursday with a well-received debt auction that raised 5.8 billion euros, selling above its target range at lower borrowing costs.

Most demand was for paper maturing in March 2015 that would be covered by a European Central Bank bond-buying programme if Spain applied for international aid, offering an additional safety net for investors seeking higher rates of return.

"It was a good auction. Demand was strong for three... reasons: risk aversion indicators are at a low, volatility has nose-dived and (investor) portfolios are very liquid," said Jose Luis Martinez, Citigroup strategist in Madrid.

The market's reaction told the same story, with the yield on Spain's benchmark 10-year bond dipping after the auction to 4.97 percent, its lowest level in 10 months.

Spain, which placed the 2015 bond at around half that rate, is mired in recession and the government has slashed spending to reduce a high public deficit, which has aggravated the slowdown.

It has said it will need to raise 121 billion euros ($158 billion) in bonds this year - up almost 8 percent from last year - as piles of debt mature and the country's financially troubled autonomous regions soak up huge sums in rescue funds.

At Thursday's sale, Madrid sought to raise between 4-5 billion euros, split between three maturities.

It drew demand from foreign investors, which was strongest for the longest-dated bond on sale, a market maker said.

Due in July 2026, it raised 470 million euros and was 2.9 times subscribed, compared to 2.1 times when it was last sold a year and a half ago. The average yield fell to 5.555 percent from 6.191 percent.

The March 2015 bond, which the market maker said was more popular with domestic banks, raised 3.397 billion euros, with a bid cover of 2.1 and a yield of 2.476 percent.

That paper benefited from the backstop of the sovereign bond-buying programme that the ECB launched in September, which is focused on debt of up to three years.

The same was true of a one-year bill in Italy, which sold at the lowest rate in three years as investors brushed off concerns about political tensions ahead of elections.

"Investors are hunting for higher returns, and with core euro zone paper offering yields just above zero are lured by the yields of peripheral debt," said Giuseppe Maraffino, a strategist at Barclays in Milan.

AID REQUEST?

Spanish Prime Minister Mariano Rajoy has been studying whether to request aid to bolster Spain's finances. But it is unclear whether he will follow Greece, Portugal, Ireland and Cyprus in asking for emergency help in a euro zone debt crisis now into its fourth year.

Analysts and a source with knowledge of the situation said demand on Thursday was strong from both international and domestic investors, potentially easing pressure on the government to request aid.

"Demand was impressive at both the short end and longer end with average yields lower than the previous auction, highlighting strong investor demand, both domestic and overseas," said Nick Stamenkovic, a strategist at RIA Capital Markets in Edinburgh.

"Against this backdrop the Spanish government will be in no rush to request external assistance," he said, though he added that he expected it to happen by the middle of the year.

Last year, Spain's own banks were the main buyers of the country's sovereign debt as international investors sold heavily. The country has been downgraded to just one notch above junk status by two rating agencies.

The third bond sold on Thursday, maturing in January 2018, sold at 3.988 percent compared to 4.680 percent when it was last auctioned on Nov. 8. The bid to cover rate rose to 2.6 from 1.6.

FUNDING HURDLES

Spain faces several funding humps this year, with 14 billion euros in bonds maturing in January, 15 billion euros in both April and July, and 16 billion maturing in October.

The average interest rate on all its outstanding debt has risen steadily since the debt crisis began and stood at 4.12 percent in November, according to data from the Treasury.

Meanwhile the average maturity has dropped to 6.04 years, also as of November last year, from 6.59 years in 2008, as Spain focuses on the shorter bonds that are meeting higher demand.

"Despite a more ambitious bond issuance plan, Spain is still struggling to stem its shrinking average maturity of its sovereign debt," wrote Raj Badiani, analyst at IHS Global Insight.

"...This implies that Spain will continue to face a challenging sovereign financing cycle in the next few years."

While Thursday's auction was a positive surprise, the bigger test, analysts said, would be to raise significant amounts in 10-year or longer-term issues over the coming months.

The 2015 bond was a new issue and the first Spanish bond to carry a CAC - or Collective Action Clause - intended to make it easier to restructure government bonds in a crisis.

All new euro zone government bonds issued from Jan. 1 will carry CACs, which allow a two-thirds majority of bondholders that agrees to a restructuring to force a dissenting minority to participate.

An absence of CACs on many Greek bonds allowed hedge funds to make big profits by dodging a writedown of the country's privately-held debt last year.

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