* Spain sells 3.2 billion euros of bonds
* Waning contagion fears from Portugal helps demand
* France sells almost 11 billion euros of bonds (Updates with results of bond sales, analyst comments)
By Emelia Sithole-Matarise
LONDON, July 17 Spanish bond yields dipped on Thursday after robust demand at a debt sale in Madrid 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.
Against this favourable backdrop, Spain sold 3.2 billion euros of 2017, 2022 and 2032 bonds, beating the top of its 2-3 billion target range. The three-year bond was almost four times oversubscribed at a record low yield.
The small size of the auction and the fact that the bonds on offer cheapened last week favoured a strong sale, traders said.
"The Spanish auctions were quite strong. The woes around Portugal's BES are more or less off the table so the way seems to be free now for at least another short rally," said Felix Herrmann, a market strategist at DZ Bank.
"We have a lot of redemptions and coupon payments due and supply is also taking a short summer break so the environment is quite constructive for peripherals again."
Spanish 10-year yields fell 3 basis points to 2.63 percent after the sale while Italian equivalents were down by a similar amount at 2.79 percent, heading back towards all-time lows hit last month.
GETTING IN CHEAPER
Thursday's bond sale completes about three-quarters of Spain's 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 new 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.
"These (Spanish auction) results resonate well with our view that recent peripheral tensions on the back of concerns surrounding ... Banco Espirito Santo, reflected investors' repositioning rather than reassessing the views," Rabobank strategists said in a note.
"As such the recent widening of spreads should be judged as a retracement, and hence a buying opportunity, rather than heralding the onset of a reversal."
Portuguese 10-year yields dipped 4 bps to 3.70 percent. They extended Wednesday's more than 10 bps fall after 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.
"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.
French auctions of almost 11 billion euros of conventional and inflation-linked bonds were also solid.
Demand for top-rated bonds is underpinned too by the ECB's ultra-easy monetary policy and renewed geopolitical tensions after Western countries led by the United States tightened sanctions on Russia over what they say is Moscow's failure to rein in violence in neighbouring Ukraine. (Editing by Janet Lawrence)