The 6.65 billion euros sold was only just below the maximum target of 7 billion euros, and a 60-70 point fall in yields compared to the last auction a month ago showed appetite for Italian debt was healthy.

It came in a week that has seen optimism on European stock and debt markets evaporate due to concerns that Spain was stalling on asking for international aid that could halt the spread of the euro zone's debt crisis.

"The issue for the time being is not Italy, the issue is Spain, but they will be pleased they managed to get this one away. Each one of these auctions is a challenge every time it comes along," said Marc Ostwald, strategist at Monument Securities in London.

"Given there was a reasonable concession made ahead of the auction, above all yesterday and (this) morning, it's gone fine. Demand still very much more domestic than anything else," he said.

The yield on Italy's five-year BTP bond maturing on June 1, 2017 dropped to 4.09 percent compared with 4.73 percent at end-August sale. On the 10-year bonds maturing in 2022, it fell to 5.24 percent from 5.82 percent.

At the same time the Treasury sold 1 billion euros of five-year floating rate notes.

The bid to cover ratio was 1.38 time the offer on the five-year paper, down from 1.46 at an end-August sale. On the 10-year bond demand was 1.33 time the offer comparing with 1.42 one month ago.

"All in all it's been pretty well absorbed and the market is still continuing to believe that despite all the tensions in the last couple of days the ECB will come and intervene when necessary in Spain and that will give some support to Italy as well," said Nick Stamenkovic, strategist at RIA Capital Markets.

On Thursday, Spain is expected to present its 2013 budget draft, which many market players reckon could form the basis of a potential bailout deal in the future.

Madrid's reluctance to ask for external help has dented market sentiment in the past few days, hoisting sovereign yields of euro zone peripheral countries.

However, Italy has paid lower yields both at a two-year zero-coupon sale on Tuesday and at a six-month bill auction on Wednesday.

(Reporting by Francesca Landini and London bonds desk; editing by Patrick Graham)

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