* 12-month yields drops to 3.505 pct, below Spain's 3.918 pct
* 6-month yield also much lower than in June
* Analysts say investor confidence improving, no contagion
LISBON, July 18 (Reuters) - Portugal sold all 2 billion euros of Treasury bills on offer at a sale on Wednesday with its cost of borrowing in the short-term now less than the Spanish equivalent - some measure of the easing of pressure on one of the countries already bailed out in the euro zone's debt crisis.
The interest the government pays on its 12-month bills fell to 3.505 percent from 3.834 percent in the previous auction in June. The 6-month paper yielded 2.292 percent, down from 2.653 percent previously, continuing a steady decline that started several months ago.
Debt-laden Portugal has been labouring under an EU/IMF fiscal adjustment programme since a rescue in May of last year. Spain, which has not requested a full-blown bailout but has agreed on 100 billion euros in aid for its banks, sold 12-month T-bills at a yield on Sunday of 3.918 percent.
"In terms of investor concern, pressure is easing on the Portuguese bills," said Orlando Green, debt strategist at Credit Agricole in London.
"The fall shows politicians, albeit at a slow pace, are making progress and pushing the austerity agenda."
Portugal and Spain are both struggling with the problem of generating enough growth to bring down a substantial debt burden, and Lisbon is more than a year into a determined programme of public sector reforms that it hopes will make its economy more competitive.
Filipe Silva, debt manager at Banco Carregosa, added: "The fact that the yield is well below Spain's shows that Portugal is not suffering from contagion from the neighboring country's situation this time, and there is greater investor confidence in the Portuguese adjustment."
After approving the latest release of funds under Portugal's 78-billion-euro bailout, the IMF said on Tuesday that Portugal has a "reasonably strong" chance of turning the country around.
"The (EU/IMF/ECB) troika has found no problems in Portugal and the auction is also an indication of that," Green said.
Portugal, cut out of debt markets since requesting a bailout last year, is expected to regain access to capital markets in late 2013 but the task of meeting a deficit of 4.5 percent of gross domestic product this year and 3 percent next year remains challenging amid a spiralling recession.
Portugal's benchmark 10-year bond yields, which have dropped from record highs of over 17.4 percent since January, were little changed at around 10.6 percent on Wednesday.
The IMF has said declining T-bill yields in auctions and bond yields in the secondary market show the government is gradually rebuilding investor confidence, boding well for a planned return to the longer-term debt market in late 2013.
The IGCP debt agency placed 1.25 billion euros in 12-month and 750 million euros of 6-month T-bills in Wednesday's auction. Demand outstripped the amount placed by 2.4 times on 12-month bills and 3.8 times on the 6-month maturity.