By Carmel Crimmins and Nigel Davies

DUBLIN/MADRID, Aug 17 (Reuters) - Irish and Spanish debt
auctions attracted strong demand on Tuesday and allayed concerns
about the pressure on costs of funding for euro zone countries
saddled with high debt and poor growth.

Irish debt spreads fell from three-month highs and the cost
of protecting against a sovereign default fell from 17-month
peaks after Dublin hit the top of its 1.5 billion euros target
range in spite of jitters over the escalating cost of cleaning
up its banking sector.

Yields that Ireland's central bank governor has called
"ridiculous" fell compared to a month ago, as did Spain's,
helping the euro extend gains against the dollar and come off
7-week lows against the yen.

"Much better than the markets had expected, and there is
some relief that Ireland was able to put away the bonds. So the
euro is seeing a bit of a rebound," said Ian Stannard, senior
currency strategist at BNP Paribas.

Concerns that Ireland, Spain and other euro zone
"peripheral" borrowers will struggle to dig themselves out of
crisis in a vicious circle of budget cuts and faltering growth
have returned to haunt markets in recent sessions.

The average return investors demanded on Ireland's 10-year
bond fell to 5.386 percent compared to 5.537 percent at a sale
in July. Spain sold 5.51 billion euros of 12- and 18-month
treasury bills at yields of 1.84 and 2.08 percent respectively,
down 38 and 24 basis points on July.

But the yield on Ireland's 2014 bond was still higher than
in May, pointing to continuing nerves that it could be next to
follow Greece into crisis.

Central bank governor Patrick Honohan warned that
governments needed to convince investors that they were
committed to cutting their budget deficits, even as he hinted
the cost of the bank bailout may rise further.

"The sooner the markets are convinced, the sooner the
interest spreads will shrink to the benefit of all," Patrick
Honohan said in a speech to Renmin University in Beijing.

"There is, for these stressed sovereigns, no question as to
whether national growth is best served by bringing the public
finances back promptly to a convergent path."

Spain and Ireland have committed to getting their fiscal
houses in order but anaemic domestic demand, soaring
unemployment and, in Ireland's case, the cost of an ongoing bank
bailout, are potential stumbling blocks.

MORE CUTS NEEDED

Ireland's budget deficit ballooned to 14 percent of gross
domestic product, the highest in Europe, last year due to the
cost of propping up nationalised lender Anglo Irish and it could
explode to around 20 percent this year if Dublin injects an
additional 10.05 billion euros into the bank.

The Anglo injection is meant to be a one-off and Honohan
reiterated on Tuesday that Ireland was committed to reducing its
deficit to an EU target of 3 percent of GDP by 2014.

Fitch ratings agency told Reuters that Dublin may have to
slash more than the 3 billion euros in savings earmarked for the
2011 budget to fully restore investor faith in Irish finances.

"I think that the markets would welcome a larger cut,
perhaps four billion, and I do appreciate that that will be
difficult and politically unpopular," Chris Pryce, Fitch
director for ratings in western Europe, said.

Dublin attracted total bids of 5.1 billion euros in
Tuesday's sale, the strongest demand in an auction so far this
year and in stark contrast to the ice-cool reception for Irish
paper in the secondary market in recent weeks.

Ireland's debt management agency expected Irish yields to
fall in the coming months. The Irish/German 10-year government
bond yield spread is still north of 300 basis points.

"There's no doubt about that and there's still an 'Anglo
Irish Premium' in that particular spread and some sort of
certainty in the future of that bank would help bring it down,"
said Dermot O'Leary, chief economist at Goodbody Stockbrokers in
Dublin.

Spain, which has hinted it could backtrack on some of its
planned cuts in infrastructure spending, sold 5.51 billion euros
of debt, at the top end of its target of 4.5-5.5 billion euros.

The spread on Spanish 10-year paper over German government
debt contracted by around 9 basis points to 168 basis points on
Tuesday.