* Spain to sells 3 bln euros of bonds, longer yields rise * Bunds choppy ahead of expected ECB rate cut * Ireland returns to market with bill sale By Kirsten Donovan LONDON, July 5 (Reuters) - Spanish government bond yields extended this week's rise on Thursday as the market digested a 3 billion euro debt auction which drew adequate demand but saw longer-term borrowing costs rise sharply. Safe-haven German Bunds struggled for direction in choppy trade ahead of a European Central Bank policy meeting where expectations are for rates to be cut to a new record low, with many investors staying on the sidelines ahead of the decision. Traders said the Spanish auction was mainly supported by domestic investors, as has been the case for much of this year. Ten-year borrowing costs rose to 6.43 percent, compared with 6.04 percent at last month's auction, although shorter-dated costs edged lower versus previous sales. "The bidding (for the 10-year) was very scrappy," said Marc Ostwald, rate strategist at Monument Securities in London. "It's indicative of the lack of liquidity, it also is indicative that neither the domestic (investors) nor anybody else are confident that what has been cobbled together so far is any solution for Spain." Euro zone leaders agreed last week to allow the bloc's bailout funds to buy bonds in secondary markets and directly recapitalise ailing banks. But scant detail on how the plans will be implemented and opposition from Finland have dampened initial positive market reactions to the accord. Spain secured up to 100 billion euros of aid for its battered banking sector last month but concerns persist that the euro zone's fourth-largest economy will eventually need a full sovereign bailout. Spanish 10-year yields were 16 basis points higher at 6.57 percent, with the Italian equivalent up 6 basis points at 5.82 percent. While some "fast money" accounts such as hedge funds piled into the market after the summit to close out bets on the bonds falling further, traders consistently reported that they were not seeing any buying of the paper from longer-term investors. "It feels like the forced buying, the short covering, we saw after the summit has been done now," a trader said. France also sold 7.8 billion euros of bonds with core paper supported by almost 40 billion euros of German redemption and coupon payments this week, and a further 50 billion euros of payments next week from triple-A rated countries including France, according to Reuters data. Meanwhile Ireland, whose five- and 10-year bond yields are currently below those of Spain, returned to the debt market for the first time since September 2010, selling 500 million euros of three-month T-bills at an average yield of 1.8 percent. Analysts had expected a yield of between 2 and 3 percent and said anything below 2 percent would be considered a success. "Every aspect of the T-bill auction is better than expected," said Credit Agricole rate strategist Peter Chatwell. "The yield of 1.8 percent is not only lower than the grey market before the auction but is approximately where Spanish bills are trading, so the parallels to Spain's debt market extend into the very short end." ECB EXPECTED TO CUT RATES The ECB will announce its policy decision at 1145 GMT, with dismal economic data paving the way for the central bank to cut its main refinancing rate by 25 basis points to just 0.75 percent. "Every cut helps to a degree, but in terms of sovereign debt markets stabilising, the question marks remain over last week's summit measures" said Brian Barry, fixed income strategist at Investec. "Investors really at this stage of the game are moving towards some kind of fiscal integration or euro zone bond, and we're still a way from any movement on that from the core countries." The Bank of England is also expected to launch a third round of monetary stimulus. September Bund futures were flat at 142.32, with 10-year yields up almost a basis point at 1.46 percent. "Twenty-five basis points seems to be the consensus and there's probably going to be some disappointment if (the ECB) don't deliver," a trader said. "Or perhaps the expectations just shift to next month. At the end of the day the data's not great, rates are staying lower for longer and there's not many reasons to sell Bunds."

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