(Updates with bond yields in fourth paragraph, comments from analysts in fifth and seventh.)

Dec. 20 (Bloomberg) -- Spain sold 5.64 billion euros ($7.36 billion) of bills, more than the maximum target, and yields fell as the European Central Bank prepared to start offering banks unlimited three-year loans later today.

The Madrid-based Treasury said it sold three-month debt at an average yield of 1.735 percent, compared with 5.11 percent at an auction on Nov. 22. It sold six-month paper at 2.435 percent, down from 5.227 percent last month.

Demand for the three-month securities was 2.86 times the amount sold, compared with 2.85 last month, and the bid-to-cover for the longer-dated paper was 4.06 times compared with 4.92 previously. Spain aimed to sell as much as 4.5 billion euros.

Spanish and Italian bonds gained as the ECB prepares to offer banks unlimited cash at its benchmark rate of 1 percent to encourage lending and stave off a credit crunch. The yield on Spain’s 10-year benchmark bond fell to 5.092 percent at 12:35 p.m. in Madrid from 5.184 percent before the sale. The ECB, which will allot the funds tomorrow, has also loosened rules on the collateral lenders can use so that they can borrow more.

The result of Spain’s auction “is partly related to the tender rather than a sudden and complete change in sentiment toward the peripheral European markets,” said Elisabeth Afseth, a strategist at Evolution Securities Ltd. in London. “It may be Spain is benefitting more from this than other countries as it has a larger banking sector which is a little more immune to the clear scrutiny of shareholders.”

Buying Debt

The Bank of Spain is urging lenders to borrow all the funds they need, two people familiar with a meeting held last week said yesterday, declining to be identified because the gathering was private. Banco Bilbao Vizcaya Argentaria SA Chairman Francisco Gonzalez called for the ECB to set up three-year lending operations so that banks can buy government debt in a Nov. 28 column in the Financial Times Deutschland.

“Spain is offering a more convincing story to investors right now and, with the additional help from the ECB, is proving more successful in getting its banks to buy its debt,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “Mr Rajoy’s government has a window of opportunity to shore up confidence in Spain’s debt market.”

People’s Party leader Mariano Rajoy will be voted in as prime minister by Parliament today after his landslide win in Nov. 20 elections. Rajoy said yesterday all components of public spending except pensions may be reduced as part of his plan to regain investor confidence and recover Spain’s AAA rating.

The last time Spain auctioned three-month debt, on Nov. 22, its borrowing costs doubled as it had to pay more than Greece and Portugal, and it sold six-month bills at the highest yield since 2004.

--Editors: Jeffrey Donovan, Alan Crawford

To contact the reporter on this story: Angeline Benoit in Madrid at abenoit4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net