Money markets us sells bills at low rates, spanish bank cds falls

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* U.S. sells 3-, 6-month bills at historically low rates * Spanish bank default insurance costs ease * Investors worry Spanish bank rescue to push up borrowing costs By Chris Reese and Ana Nicolaci da Costa NEW YORK/LONDON, May 29 The U.S. Treasury sold three-month and six-month bills at comparatively low interest rates on Tuesday, indicating investors remain hungry for lower-risk, short-term U.S. debt amid worries over contagion from Spain's ailing bank sector. The United States on Tuesday sold $30 billion of three-month bills at a high rate of 0.085 percent, unchanged from a similar sale of the bills last week, when the auction rate was the lowest since April 23. A total of $27 billion of six-month bills was auctioned on Tuesday with a high rate of 0.14 percent, which was also unchanged from a similar sale last week which brought the lowest rate since an April 23 auction. While historically low, the auction rates for the bills remain above the lowest levels reached last year. Three-month bills were sold at a high rate of 0.005 percent in December of last year, while six-month bills were sold at a high rate of 0.03 percent in September. Meanwhile, Spanish efforts to recapitalize Bankia, its fourth-biggest lender, have eased pressure on the cost of insuring Spanish bank debt against default - but not for long because the move is seen as further undermining the country's precarious finances. The fate of Spain and its banking system is increasingly intertwined as markets worry that any bank rescue will further drive up national borrowing costs in a vicious cycle. The cost of insuring debt issued by Santander and BBVA fell on Tuesday, having risen in the beginning of May when risk sentiment was also hurt by an anti-austerity vote in the Greek elections. But analysts expect the fall in the cost of insuring Spanish bank debt against default to be short-lived and that spreads will realign with those on sovereign bonds on concerns that Bankia could be just the start of a rolling rescue of an over-leveraged banking system. Bankia's parent company BFA has asked for 19 billion euros in government help, in addition to 4.5 billion the state has already pumped in to cover possible losses on repossessed property, loans and investments. Analysts worry that Spain could eventually be forced to seek an international bailout with unforeseeable consequences for the euro zone and financial markets. A government source told Reuters on Tuesday Spain will recapitalize the nationalized lender by issuing new debt, not by injecting bonds, and will likely adopt on Friday a new mechanism to back its regions' debt. "I guess a couple of weeks ago we didn't have news about this bailout. I am surprised that people have taken it that optimistically. I guess having something injected is better than nothing," Michael Hampden-Turner, credit strategist at Citigroup said. "We are likely to see quite a lot of volatility in the bank CDS premium as the summer goes on. We see some volatility but I think it's probably a temporary thing. I think it's likely to realign (with sovereign CDS prices)." The cost of insuring debt issued by Santander against default fell 11 basis points on the day to 401 bps, while the BBVA equivalent shed 10 bps to 441 bps, according to Markit data. Five-year Spanish sovereign CDS meanwhile flirted with a record high of 560 bps, trading at 556 bps - little changed on the day and up from 508 bps in late April. Ten-year Spanish government bond yields also remained above 6 percent danger levels and not far from 7 percent - a level where Portugal and Ireland had to start considering bailouts. "It seems like (increasingly) the credit risk is being transferred over to the sovereign fundamentally, that's why we have seen Spain hovering near its record wide," Markit analyst Gavan Nolan said. On bank CDS prices, he said: "They had widened out a lot in the previous few weeks. Mainly I think it's a bit of a pull-back from that." The trouble for Spanish banks could worsen if clearing house LCH. Clearnet SA further increases the cost of using Spanish bonds to raise funds via its repo service. Earlier this month the clearer raised the initial margin on two- to 30-year Spanish debt, with the largest move in the 10- to 15- year maturity sector. "Imposition of higher initial margin charges from LCH on Spanish government repo is almost an inevitability now. This may further depress liquidity in both the underlying government bond market and term repo market for Spain," Don Smith, economist at ICAP said.