* Spain to sell up to 3 billion euros of bonds
* Waning contagion fears from Portugal to help demand
* France also sells up to 10 billion euros of bonds
By Emelia Sithole-Matarise
LONDON, July 17 Spanish bond yields held steady on Thursday before a debt sale seen drawing strong demand as fears recede of contagion from the financial troubles faced by the founding family of Portugal's biggest listed bank.
The euro zone bond market has stabilised this week with investors more optimistic that Lisbon-listed Banco Espirito Santo will be able to deal with any exposure to problems facing companies of its founding family.
Spanish and Italian bonds have traded independently of junk-rated Portuguese and Greek debt, with market participants saying the concerns around BES pose no systemic risk for the euro zone.
This made for a favourable backdrop for the Spanish debt sale of up to 3 billion euros of 2017, 2022 and 2032 bonds.
The small size of the auction and the fact that the bonds on offer cheapened last week favoured a strong sale, traders said.
"It should be well supported. There's good reason to believe that the nature of the BES issue ... should be contained and not something that should become a systemic issue," said Anton Heese, a strategist at Morgan Stanley.
"Net supply over the next quarter is negative so it's not as if the market is being called up to absorb large amount of supply over the next few months. That's also a supportive factor."
Spanish 10-year yields were flat on the day at 2.66 percent while Italian equivalents were a touch lower at 2.82 percent.
GETTING IN CHEAPER
Thursday's bond sale will see Spain complete around 70 percent of its 2014 funding programme. Both Madrid and Rome have ramped up their debt sales, taking advantage of an investor hunt for yield that has driven their borrowing costs to record lows.
The prospect of a fresh round of European Central Bank long-term loans to banks later this year is fuelling demand for peripheral euro zone bonds, which still offer relatively higher yields than those on better-rated euro zone bonds.
Additionally, some investors see last week's sell-off in the periphery as an opportunity to buy at cheaper levels.
"We expect a successful auction, with investors who have missed the huge rally this year possibly taking advantage of the recent setback to accumulate exposure," Unicredit strategists said in a note.
France will also sell up to 8.5 billion euros of two-, four- and five-year bonds as well as up to 1.5 billion euros of 2018 and 2024 debt linked to euro zone inflation and 2021 paper linked to French inflation. Bond redemptions from core euro zone countries this week and the ECB's ultra-easy monetary policy are seen supporting demand there too.
Portuguese 10-year yields were steady at 3.74 percent after falling more than 10 bps on Wednesday on reassurances from BES and Lisbon that the bank was well capitalised and able to deal with any exposure to the troubled companies of the Espirito Santo family. (Editing by Catherine Evans)