* Ireland sells 4.2 bln euros of new bonds, switches 1 bln
* Offers five-, eight-year paper at yields of 5.9, 6.1 pct
* First Irish bonds offered to new investors since Sept 2010
* Dublin makes further inroads on 2014 funding cliff
By Padraic Halpin and Lorraine Turner
DUBLIN, July 26 Ireland took a major step towards exiting its EU/IMF bailout on Thursday and gave the euro zone debt crisis a rare glimmer of hope when it sold new long-term government bonds for the first time since 2010, raising 4.2 billion euros of fresh debt.
In the biggest test of sentiment since it was forced out of bond markets in September 2010, Ireland launched its second bond swap in six months on Thursday but in a surprise move, also opened the sale of five- and eight-year paper to new investors.
Ireland's debt agency said new investors snapped up 4.2 billion euros of the new 2017 treasury bond and existing 2020 issue, equivalent to 2.6 percent of the country's annual economic output and far ahead of expectations.
Holders of paper maturing in 2013 and 2014 exchanged 1 billion euros of their existing debt, meaning Ireland cut a further 5.2 billion euros from hefty borrowing requirements that threatened to leave it needing extra aid in 2014.
"The strong demand and the fact that over 4 billion euros of this is new money is a significant step for Ireland in regaining our economic sovereignty," Irish finance minister Michael Noonan said in a statement, adding that he understood the majority of the demand came from foreign investors, particularly in the U.S.
The head of the National Treasury Management Agency (NTMA), John Corrigan, said it had now covered a significant proportion of the 8.2 billion euros bond maturing in January 2014, which up until now has been seen as a challenging 'funding cliff'.
The NTMA said 3.8 billion euros of the total amount committed went into the 2017 bond at a yield of 5.9 percent, with 1.3 billion added to the existing 2020 issue that offered a yield of 6.1 percent.
While that is significantly more than the 3 percent Ireland pays its EU and IMF lenders, it's less than the 6.4 percent Spain had to offer sell five-year bonds last week and the 6.7 percent to offload eight-year paper.
"A SAFER BET"
The debt swap was the second the agency has undertaken this year. It successfully cut 3.5 billion euros in January from its hefty 2014 borrowing requirements, but the notes offered then were relatively short-term.
Of those who exchanged existing paper, two-thirds switched out of the 2014 bond.
Dublin, which returned to short-term debt markets earlier this month at a lower cost than Spain, has been in a race against time to pre-fund the January 2014 bond redemption -- nearly half its 18 billion euro full-year borrowing need.
It will also start eating into that total by issuing annuity bonds to Irish-based pension funds and inflation-linked bonds also aimed at domestic investors for the first time last this year, with the aim of raising 3 to 5 billion euros over the next 18 months.
While the deepening euro zone crisis has forced Spain and Italy to issue debt at higher yields, Irish borrowing costs have fallen sharply following last month's EU summit when leaders agreed to look at improving the terms of Ireland's bank bailout.
Yields on Ireland's benchmark 2020 bond were traded at 6.27 percent as the auction closed, down 100 basis points on a month ago and almost 70 points lower than Spain which has so far avoided seeking a full sovereign rescue.
The NTMA has continuously said it needs relative calm across Europe if it is to make a sustained return to longer-term bond markets and will have noted comments by European Central Bank President Mario Draghi on Thursday, pledging to do whatever was necessary to protect the euro zone from collapse
Corrigan also said last week that a significant improvement to the terms of Ireland's bank rescue would also greatly enhance the country's market prospects, while Noonan reiterated on Thursday that such an outcome was essential for a full return.
Ireland also faces the tough task of cutting to 3 percent of gross domestic product (GDP) by 2015 a budget deficit that, at 9.4 percent of gross domestic product, was the worst in the European Union last year.
"That funding cliff is considered the biggest obstacle to Ireland exiting the troika programme, it now seems to be taken care of to a large extent today," said Owen Callan, senior dealer at Danske Markets, a primary dealer in Irish bonds.
"If you look at the periphery, if you look for a yield from that point of view, Ireland seems a bit of a safer bet than what's going on in Spain and Italy at the moment."