* But short-term yields rise on Catalan independence push
* Bonds still set for worst week in three months
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates after auction result)
By Dhara Ranasinghe and Paul Day
LONDON/Madrid, Oct 5 (Reuters) - Spain's financial markets recovered ground on Thursday after solid demand at a debt auction was seen as a positive for Spanish assets shaken by tensions between Madrid and region Catalonia, which is set to declare independence.
The number of bids at the auction was more than twice the amount offered on every one of the three lines, although yields on the short-term debt did jump -- a sign of nerves ahead of an expected declaration on Monday following a banned referendum.
The yield on Spain's benchmark 10-year bond fell on Thursday after three consecutive days of rises, but Spanish bonds were still set for their worst week in three months.
Spain's IBEX stocks index also recovered from its biggest one-day fall in over a year, to trade up 0.5 percent on the day.
"The (auction) result was very good, given that we really didn't know what to expect," said Antoine Bouvet, a rates strategist from Mizuho.
"But I think in the short term, we are at the mercy of political events. So while this is a good sign for Spanish bonds, there is still some uncertainty ahead."
Catalan President Carles Puigdemont said on Wednesday he favoured mediation to find a way out of the crisis but that Spain's central government had rejected this. Prime Minister Mariano Rajoy's government responded by calling on Catalonia to "return to the path of law" before any negotiations.
Ratings agency S&P late on Wednesday put Catalonia's ratings on "credit watch negative" on an escalation of the political conflict. S&P's long-term rating for Catalonia is B+, four notches below investment grade.
Spain's 10-year bond yield was 3 basis points lower on the day at 1.75 percent, having earlier climbed to its highest level since March at 1.81 percent.
It is still up 14 basis points this week, however, on track for its biggest weekly rise in three months.
The premium investors demand for holding Spanish bonds over top-rated German peers was 130 bps, having stretched to around 136 bps in the previous session -- its widest since late April.
"Even though our base case assumption remains that Catalan independence (even if unilaterally declared) will not happen, we suspect things might still get worse before they get better, and target a return of the 10-year Spain/Germany (yield spread)to back above 140 bps," analysts at ING said in a note.
Germany's 10-year bond yield was 1 basis point lower on the day at 0.44 percent, falling in line with most other euro zone bond yields.
Focus was expected to turn to the minutes of the last meeting of the European Central Bank, due out later in the day.
That comes as investors try to assess the likely timing and scale of an unwinding of the ECB's massive stimulus scheme.
Writing by John Geddie; Reporting by Dhara Ranasinghe and Abhinav Ramnarayan in London and Paul Day in Madrid; Editing by Catherine Evans