By Elisabeth O'Leary
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MADRID (Reuters) - Spain vowed on Thursday it would not follow ailing neighbor Portugal in seeking a European bailout, and a successful Spanish bond auction suggested markets do not immediately fear contagion.
The fall of another euro zone domino after Greece and Ireland focused attention on Madrid and the efforts that its government, and European authorities, have poured into erecting a firewall to buttress its public finances.
"(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," Spanish Economy Minister Elena Salgado told national radio station SER.
But news that Greece has fallen behind on its deficit reduction target, and rising expectations that Athens will have to restructure its debt, showed that the single currency area has yet to fully resolve the sovereign debt and banking crisis.
Caretaker Prime Minister Jose Socrates announced on Wednesday that Portugal was asking for financial assistance from the European Union, saying the economic risks had now become too great to go it alone after borrowing rates soared.
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While European Union officials voiced relief, non-euro zone Sweden criticized Lisbon for waiting too long.
"They should have requested aid much earlier," Swedish Finance Minister Anders Borg told journalists. "They have placed themselves and Europe in a very difficult situation.
The European Commission said Portugal had not yet made a formal request, and a senior euro zone source said Lisbon would have to make clear if its caretaker government has the authority to negotiate a bailout before a June 5 general election.
The EU executive also said Spain was on track to fulfill its deficit reduction targets.
But a source close to Greece's international lenders told Reuters that Athens' 2010 budget deficit would be revised to above 10 percent of gross domestic product, requiring corrective measures to stem spillover effects.
EU paymaster Germany's leading economic institutes said they expect Greece's sovereign debt will be restructured -- a view shared by a majority of Greeks, according to an opinion poll released on Thursday.
That could cast Greece into a deeper economic depression and cause problems for convalescent European banks, particularly in Germany and France, the two main foreign holders of Greek public debt. Diplomats say this is one key reason why euro zone governments and the European Central Bank are anxious to delay any such move until after 2013.
The long-anticipated Portuguese call for help turned the spotlight back on Spain and its weakened finances, but the Treasury easily sold 4.1 billion euros of 3-year bonds on Thursday without yields spiking up.
"The auction confirms that investors separate Portugal from Spain," said Estefania Ponte, economist at Cortal Consor in Madrid.
The risk premium on Spanish 10-year bonds compared with the German benchmark widened slightly to 181 basis points on Thursday after narrowing in early trade, but was still close to a two-month low.
Spanish 10-year yields are around 5.2 percent compared to the 6.1 percent Portugal was paying shortly after Ireland was rescued last November. Benchmark German 10-year yields have risen by around 50 basis points since then.
Whether Spanish rates 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.
The next expected step is a reform of collective bargaining, breaking the link between inflation and wages, expected in mid-April after the government gave unions and employers longer to reach an agreement.
Spain had about 25 billion euros ($34 billion) in foreign direct investment in Portugal in 2009, the last available figures, and Spanish banks have $98.3 billion in total exposure to their neighbor, around a third of its foreign-owned debt.
Analysts say Madrid is shielded as long as a rescue package comes through for Lisbon, but some 8.5 percent of Spain's exports go to Portugal, so the budget austerity that accompanies a bailout is 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.
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 due 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.
(Additional reporting by Nigel Davies and Manuel Maria Ruiz in Madrid; Ingrid Melander and Harry Papachristou in Athens, Charlie Dunmore in Brussels, Niklas Pollard in Stockholm; Writing by Paul Taylor and Fiona Ortiz; editing by Patrick Graham)