By Elisabeth O'Leary

MADRID (Reuters) - Spain will not follow ailing neighbor Portugal in seeking a European bailout, Spain's Economy Minister said on Thursday, hoping Lisbon's move will draw a line under Europe's debt crisis.

Caretaker Prime Minister Jose Socrates announced late on Wednesday that Portugal was asking for financing from the European Union, the third euro zone member to do so after Greece and Ireland last year. He argued the economic risks had now become too great to go it alone after borrowing rates soared.

"The market continues to give Madrid the benefit of any doubt at the moment, but the auction performance will be scrutinized for any hints of waning investor interest on this front," Lloyds analysts wrote in a daily note.

The risk premium on Spanish 10-year bonds compared with the German benchmark narrowed slightly on Thursday morning, to 179 basis points.

Whether they fall further is likely to depend on investors keeping faith with Madrid's drive to cut its deficit aggressively and revive an almost-stagnant economy struggling with high unemployment.

SALGADO RULES OUT CONTAGION

"(The risk of contagion) is absolutely ruled out ... it has been some time since the markets have known that our economy is much more competitive," Economy Minister Elena Salgado told national radio station SER.

Spain had about 25 billion euros ($34 billion) in foreign direct investment in Portugal in 2009, the last year of available figures, and Spanish banks have $98.3 billion in total exposure to the country next door, holding around a third of its foreign-owned debt.

Analysts say Spain is shielded as long as a rescue package comes through for Lisbon, but some 8.5 percent of Spain's exports are sent to its western neighbor, meaning that the budget austerity that will accompany a bailout are likely to have a knock-on effect.

"Portugal's bailout request puts the likes of Spain under the spotlight, but we are of the opinion that Spain will not follow due to its improving fiscal situation and recovering economy, while also passing key structural reforms in the labor market and pensions," Credit Agricole analysts said in a note to clients.

ECB IMPACT

Spain dragged itself out of an 18-month recession at the start of last year but growth has stuttered since then and the central bank and many economists doubt the economy can grow as much as the government expects.

Official forecasts for growth in 2012 and 2013 were cut to 2.3 percent and 2.4 percent respectively, pointing to the likely impact of higher interest rates and oil prices.

But Salgado argued that a widely-expected quarter point interest rate rise by the European Central Bank on Thursday would not endanger an economy already dealing with harsh public spending cutbacks and labor market reforms.

"The impact of a small rise in rates is very slow. Mortgages (in Spain) are only revised once a year and so the transmission (of a rate rise) is not immediate," she said.

Spanish banks are seen as among the most vulnerable in Europe to a series of ECB rate hikes. Although one round of higher rates will not cause problems, further hikes will squeeze profit at banks and push already-stretched borrowers into arrears, analysts said [ID:nLDE7340WD]

(Reporting by Elisabeth O'Leary; Writing by Fiona Ortiz; editing by Patrick Graham)