* Spain uncertainty keeps euro sentiment fragile * Bunds take a breather after Wednesday's solid gains * Borrowing costs, demand fall at Italian auction By Marius Zaharia LONDON, Sept 27 (Reuters) - Spanish government bond yields were stable on Thursday as uncertainty over how quickly the country would ask for a bailout kept investors edgy while Madrid prepared to unveil what has been billed as a tough 2013 budget. The fragile market mood in the euro zone was in part reflected in an Italian auction, which saw lower demand than previous sales. But borrowing costs also fell in line with levels in secondary markets. Spain is expected to announce a series of economic reforms alongside the draft budget, aiming to avoid the political humiliation of having Brussels impose conditions on a request for international aid. Prime Minister Mariano Rajoy is inching closer to asking the EU and European Central Bank for more support but he has been resisting pressure to do so swiftly. Rajoy's hesitation to make a move that has seen other European prime ministers losing their jobs coincides with violent anti-austerity protests in Madrid and a rise in Catalan separatism that could even call into question Spain's existence in its current form. "Spain is going through a perfect storm of economic and political problems," said Ricardo Barbieri, a strategist at Mizuho. Spanish 10-year yields were 3 basis points lower at 6.05 percent, while two-year yields were 3 bps higher at 3.51 percent. Analysts expected yields to rise as markets increase pressure on Rajoy to ask for help. Pressure may also come from a Moody's rating review, which is expected by the end of the month and could see Spain losing its investment grade status. "Spanish bond yields would probably trend higher. Friday looks like a soft spot for rating announcements," Commerzbank rate strategist Rainer Guntermann said. SENSITIVE TO SPAIN Italy's five-year borrowing costs fell to their lowest since May 2011 and 10-year yields also fell at a sale of 6.65 billion euros worth of debt. While a drop in yields was expected given where secondary market prices were before the sale, the falling demand was taken as a sign that the Spanish problems are affecting Italy as well. The bids for the five-year bond were 1.38 times the amount on offer, down from 1.46 at a sale on Aug. 30. For the 10-year bond, the bid-to-cover ratio was 1.33, compared with 1.42 a month ago. "Demand ... was decent but not exceptionally strong. Investors are still sceptical on the development of the EMU debt crisis," said Annalisa Piazza, a market economist at Newedge Strategy. Italian 10-year yields were last 3 bps lower at 5.18 percent. German Bund futures were 18 ticks lower at 141.45, taking a breather after rising almost one-and-a-half points on Wednesday. Uncertainty over Spain has pushed the contract higher in recent sessions, after it hit a 5-1/2 month low of 138.41 on Sept. 17. Commerzbank's Guntermann recommended investors a "tactical short" position for Thursday, only because the previous session's rise was too sharp. He said he targeted 141.00 in the Bund future, which would be consistent with a 1.5 percent level in 10-year cash yields. "But the risks in the periphery are still valid, so this would only be a temporary correction," Guntermann said.

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