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LISBON/LONDON (Reuters) - Portugal sold its first bonds at auction in three years on Wednesday, paying a record low yield that was seen as vote of market confidence and a boost to Lisbon's chances of making a clean break from its bailout next month.
At just less than 3.6 percent and with demand easily outstripping the 750 million euros ($1 billion) sold, the results suggested Portugal would enjoy strong investor support if it chooses to leave the rescue program without the backstop of a standby European Union loan.
Whether Portugal follows Ireland in making a clean exit without a backup is a focal point of discussions with its international lenders, which began their last evaluation of its compliance with the terms of the program on Tuesday.
"The more money they can raise at very low interest rates the more it gives them an incentive to go for a clean exit," said Lefteris Farmakis, a rates strategist at Nomura.
Prime Minister Pedro Passos Coelho said the auction gave the country "strong confidence about the future", though the government was still "calmly" weighing its options concerning a possible precautionary credit line.
It would reach a decision by May 5, when Europe's finance ministers are due to meet, he told an economic conference.
Debt agency IGCP placed Wednesday's bond at an average yield of 3.5752 percent, the lowest on record in a Portuguese auction of that maturity and significantly lower than the secondary market yield of 3.68 percent registered just beforehand.
Demand outstripped the amount placed by 3.5 times.
"It's now proven that Portugal can finance itself in the tough and rough normal market without support from banks," said Filipe Silva, head of debt at Banco Carregosa in Porto.
"The yield below the secondary market is very important as it shows that investors do not demand a premium for holding Portuguese debt."
In the market, the 10-year yield hit an eight-year low of 3.624 percent immediately after the auction, according to Reuters data, before paring some of those gains.
As the European session drew to a close, the bonds were still 5 basis points tighter on the day at 3.66 percent, outperforming all other euro zone sovereign debt.
The drop in yields continued a trend of sharp declines since 2012 when they peaked at over 17 percent, driven by signs the euro zone crisis is abating, prospects of European Central Bank asset purchase and Portugal's own return to economic growth and lower deficits after a brutal recession.
As recently as February, Portugal paid 5.112 percent in a syndicated 10-year bond sale.
"Portugal has turned at least a big part of the corner, considering two or three years ago it was deemed practically insolvent," said Michiel de Bruin, head of global rates at F&C, an asset manager which holds Portuguese bonds.
The latest leg lower in the country's yield took its premium over investment grade-rated Italy and Spain to around 60 basis points, a gap that many expect to narrow further as investors price in the prospect of credit agencies lifting Portugal's ratings in coming months.
Unlike Ireland, which exited its bailout in December without a supplementary credit line, Portugal managed to resume bond auctions before the end of its 78-billion-euro rescue program.
Ireland did not hold its first post-bailout auction until last month, though at 2.967 percent its yield was much lower. Portuguese debt yields are close to where Irish yields were about a month before the end of Dublin's bailout.
"It <Wednesday's auction> is significant because Portugal's interaction with the market is now more advanced than say Ireland's was when it exited the bailout and I see very little reason why Portugal will not pursue a clean exit," said Michael Michaelides, rates analyst at RBS.
Other peripheral euro zone bond yields fell in Portugal's wake after the auction, with Greece the only country to buck that trend as traders reported some investors were selling the sovereign's bonds to make room for a debt sale by the National Bank of Greece scheduled for Thursday.
Speculation that the European Central Bank will begin an asset purchase program to ease deflationary pressure in the euro area was also driving investor flows into peripheral bonds, where returns are relatively higher than in lower risk bonds.
Wednesday's debt sale was intended to help pre-fund Portugal for 2015.
"We are not desperate like three years ago, when we didn't have funding for one month. Now we have cash for a year," Passos Coelho said.
($1 = 0.7248 Euros)
Additional reporting by Sergio Goncalves and Daniel Alvarenga in Lisbon and John Geddie in London.; Editing by John Stonestreet/Jeremy Gaunt