* Sells 500 mln eur of 3-month paper at just 0.2 pct
* Bid-to-cover rises to 3.8 vs 4.1 at Nov auction
* Reflects increasing investor confidence in euro strugglers
DUBLIN, Jan 17 (Reuters) - Ireland paid the lowest cost for three-month debt since it resumed T-bill sales in July, in another sign of rising investor confidence a week after it covered a quarter of its 2013 long-term funding target.
Ireland, which embarked on a gradual return to bond markets last year, kicked off its funding for 2013 last week when it sold 2.5 billion euros ($3.3 billion) of 2017 paper ahead of a planned exit from an EU/IMF bailout later this year.
On Thursday, Ireland's debt agency saw the average yield in a sale of 500 million euros of three-month T-bills dip to 0.2 percent, down from 0.55 percent at a similar sale in November and 1.8 percent at its first auction since the bailout in July.
Ireland has sold the same amount of three-month bills on five occasions since the middle of last year amid solid demand and the latest sale was 3.8 times oversubscribed. It plans to run two further short-term auctions this quarter.
The success of the sale reflects improved investor sentiment towards struggling euro zone countries, which also helped Spain cut debt costs at a bond auction on Thursday, allowing it to reach nearly 9 percent of the year's longer term borrowing needs.
Fellow bailout recipient Portugal issued 2.5 billion euros of short-term debt on Wednesday at much lower yields than before and is preparing to issue a 5-year syndicated bond similar to last week's Irish issue, according to local media.
The head of Ireland's debt agency said last week he hoped to resume monthly bond auctions at some point this year, and that his team would discuss a 10-year benchmark issue and possible U.S. syndicated issue with investors in the coming weeks.
The National Treasury Management Agency (NTMA) aims to raise 10 billion euros in long-term funding this year to cover its remaining post-bailout needs for 2014, much of which was already covered through last year's activity.