* Spanish sale seen going smoothly but yields should rise * Solid demand seen at French auction * German Bunds lower on equities, strong resistance at 145.97 By Ana Nicolaci da Costa LONDON, July 19 (Reuters) - Ten-year Spanish government bond yields hovered close to 7 percent danger levels on Thursday, shortly before Madrid goes to the market seeking funds over two to seven years. France is also due to sell bonds, maturing in 2015, 2016 and 2017, in what is seen as an especially favourable environment following Germany's auction of two-year bonds at a negative yield this week. Returns of zero or less on debt of the euro zone's highest-rated borrowers has pushed investors to seek returns in higher-yielding but still relatively safe French paper, and the country has recently borrowed at historically low costs. Short-term Spanish T-bill yields dropped from a month earlier at an auction on Tuesday and recent price cheapening was expected to help the bond sale of between 2 and 3 billion euros, but yields are seen rising as investors remain unconvinced of the country's ability to control its finances.. "We are reasonably optimistic that it will not be a bumper auction and that it will go ahead and that's the most important thing at the moment for the Spanish government," Piet Lammens, strategist at KBC said. Ten-year Spanish government bond yields rose 4.1 basis points to 6.99 percent, near the 7 percent level beyond which funding costs are deemed unsustainable over the long-term. Five-year Spanish bond yields were up 11 bps at 6.45 percent, while two-year yields firmed 6 bps to 5.14 percent. German Bund futures came under pressure after hitting their highest in six weeks in the previous session and as a strong performance in global stock markets took the shine off the safe-haven asset. The September Bund future fell 23 ticks to 145.11, having risen in the previous session as far as 145.50. KBC's Lammens said there was strong resistance at 145.97 -- the contract high. "Technically some stronger trigger probably is needed to get over this resistance. So long as that doesn't happen, we think there are risks for mild profit-taking in the global core bonds market," Lammens said. FRANCE Only a couple of months ago, investors fretted that contagion could quickly spread from peripheral bonds to France, given its banks' sizeable exposures to debt issued by Spain and Italy. But as yields in two-year German bonds fell into negative territory for the first time after the European Central Bank cut interest and deposit facility rates, France has emerged as a favourite among higher-rated issuers. The premium investors require to hold 10-year French bonds over their German equivalent has fallen 25 basis points so far this month, which should make for a successful auction of French bonds later in the session. "The shorts have been caught the wrong way in France. France has been performing incredibly well, and if you've been short that has been pretty painful," said Huw Worthington, European fixed income strategist at Barclays. "It may well be that you will get demand from who has been in pain recently to ensure a good result." Investors will also keep an eye on U.S. regional factory activity and weekly jobless claims as they try to assess the health of the world's largest economy and gauge whether more monetary stimulus is on the way. Federal Reserve Chairman Ben Bernanke on Tuesday offered a gloomy view of the economy's prospects, but provided few concrete clues on whether the U.S. central bank was moving closer to a fresh round of monetary stimulus.

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