* Markets hit by uncertainty over future ECB intervention * Spanish short-term yields rise * Yields rise at one-year Italian T-bill auction By Marius Zaharia LONDON, Aug 13 (Reuters) - Short-term Spanish government bond yields rose on Monday, with some investors expecting Madrid's debt crisis to worsen before policymakers make any move to lower its borrowing costs. In a sign of tempering appetite for short-term debt from vulnerable sovereign borrowers, yields inched higher at an Italian one-year Treasury bill auction. Prospects of the European Central Bank resuming purchases of short-term Spanish and Italian bonds next month pushed Spanish two-year yields as low as 3.2 percent last week, but they have since pulled back up by around a point. On Monday, Spanish two-year yields were 16 basis points higher on the day at 4.22 percent, still some way off levels above 7 percent seen last month before the ECB signalled it may intervene in bond markets again to lower borrowing costs. The ECB's condition that troubled countries need to activate the euro zone's rescue mechanisms and accept supervision carries the risk that Spain's short-term yields could go back towards the levels that drove Madrid to overcome its reluctance to ask for help for its banks. "The question of when and under which conditions Spain will ask for financial support is keeping everyone in the dark," Rabobank senior market economist Elwin de Groot said. "You could argue that at these levels the pressure for Spain has eased and ... you would at least expect yields to go back up again. Whether that should be to levels seen in July I don't know though, because there is a threat that at some point the ECB will intervene." Societe Generale rate strategist Ciaran O'Hagan said there was value in short-term Spanish debt on a two-month horizon, but that prices may become more attractive in coming days due to uncertainty over the conditions Spain would have to meet to receive help. "In the end there will be an agreement, because the alternative is rather bleak," O'Hagan said. Tobias Blattner, director of macroeconomic research at Daiwa Capital Markets, still expected short-dated Spanish and Italian paper to remain underpinned by ECB intervention prospects and said the recent rise in yields was just a minor correction. The three- to five-year bonds were likely to underperform shorter-dated ones, however, as markets doubt that the ECB could intervene in these sectors, Blattner said. ITALY OUTPERFORMS SPAIN Italian two-year yields rose 4 bps on the day at 3.49 percent. The bonds have outperformed their Spanish counterparts in the past week, with the yield differential widening by some 45 bps to 68 bps. Finance Minister Vittorio Grilli told a newspaper Italy would not meet its 2012 deficit target but planned no extra budget cuts because it was on track to meet its EU obligations. Markets took that in their stride, given that Italy's budget deficit remains among the lowest in Europe. "The problem for Italy is the contagion risk more than anything else," Rabobank's de Groot said. "Market liquidity may also have an impact (leading to Italy's outperformance over Spain), as Italy is still one of the more liquid markets in the euro zone." The difference between what buyers wanted to pay for Spanish two-year bonds and what sellers wanted to receive -- an indication of trading volumes -- was more than 100 cents, double the spread in Italy and among the widest seen this year. German Bund futures were 55 ticks lower on the day at 142.85, retreating to the middle of last week's 142.17 - 143.66 range after failing to break the higher end of it earlier in the session. Traders said thin volumes exacerbated moves.

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