By John Stonestreet
MADRID (Reuters) - Spain took in its stride on Tuesday the first test of investor appetite for its debt since a two-notch ratings downgrade, selling 4.88 billion euros of treasury bills ahead of a far trickier hurdle later this week.
The Treasury had aimed to raise between 4 and 5 billion euros from the sale, a prelude to what has been dubbed a "litmus test" auction on Thursday of bonds with maturities of up to 10 years.
Yields on the 12- and 18-month paper were 2.049 percent and 2.399 percent respectively, slightly lower than expected and little more than half of what was paid to place the same maturities in December.
That sale took place before the European Central Bank fed demand for shorter-term euro zone debt with a flood of cheap three-year money.
"It's clear that the ECB's extraordinary liquidity measures have succeeded in easing the credit crunch that was spreading across Europe and opened an indirect funding channel for peripheral states," said Nicolas Lopez, senior analyst at M&G Valores.
Credit agency Standard & Poor's cut Spain's rating by two notches on Friday as part of a wave of downgrades of euro zone sovereign debt.
While the cut was priced in by markets, Spain's public finances remain under the market microscope and demand for its bonds that extend beyond the duration of the ECB money is uncertain.
"The biggest driver behind the fall in yields is the ECB liquidity actions. But the 10-year auction will provide a proper litmus test for Spanish debt," said David Schnautz, analyst at Commerzbank.
Schnautz said market sentiment had also been boosted since then by action by the new government elected in November to tackle the budget deficit after a steep overshoot in 2011, and by its plan to raise taxes despite pre-election promises not to.
Traders said the European Central Bank took action on Monday by buying bonds issued by Italy - the other major euro zone economy at the sharp end of the debt crisis - as well as Spain.
That offset pressure from the salvo of S&P downgrades, though the rising risk of a disorderly default in Greece weighed on markets.
This Thursday Spain will look to place 3.5-4.5 billion euros of paper due in 2016, 2019 and 2022, the latter two maturities well beyond the duration of the ECB loans.
Prior to Tuesday's bill auction, analysts said they expected the ten-year auction yield at around 5.5 percent.
The last time Spain sold 10-year paper was on December 15, when it paid 5.545 percent.
The 10-year bond traded at 5.14 percent, slightly lower on the day.
Estefania Ponte at Cortal Consors brokerage said Tuesday's paper would sell at yields at around 2.30 percent and 2.35 percent, respectively.
The last time Spain sold 12- and 18-month paper in December the yields were 4.050 percent and 4.226 percent.
(Additional reporting by Manuel Maria Ruiz. Reporting by John Stonestreet.)