The European Union's top economic official called on Wednesday for a stronger European financial safety net as Portugal, seen as the next candidate for a bailout, comfortably sold its first debt of the year.

EU Monetary Affairs Commissioner Olli Rehn said finance ministers should look next week at reinforcing the effective lending capacity of the euro zone's existing rescue fund and making it more flexible to calm debt markets.

Separately, the European Commission suggested in an internal report seen by Reuters that a one-off tax could be levied on banks to raise 50 billion euros to fund the future European Stability Mechanism to aid euro zone states in trouble.

Rehn told reporters in Brussels that work was in progress on changing the size and scope of the EFSF but he declined to give details of potential changes, saying it would be premature.

The effective lending capacity of the current European Financial Stability Facility should be reinforced and the scope of its activity widened, he wrote in the Financial Times.

A French government spokesman said the EU safety net was big enough as it is, repeating the position Paris and Berlin took in December in rejecting calls to increase the rescue funds.

There was no immediate response to the Commission's idea of raising a critical mass of paid-in capital for the future ESM, but the main EU member states have long opposed any form of community taxation.

On the markets, Portugal drew strong demand for its 10-year bonds and the borrowing cost actually fell slightly to 6.716 percent from 6.806 percent at its last auction, after European Central Bank buying of its bonds this week bought Lisbon time.

While the yield was below the 7 percent threshold regarded as unsustainable, analysts cautioned that this was not a make-or-break auction and Portugal has a lot more debt to sell in 2011, with a potential funding crunch in April.

Probably the most important thing for the 10-year yield is that the 7 percent level was not breached. The ECB has been very active in past days stabilizing the market and sentiment, said Michael Leister, a bond strategist at WestLB in Duesseldorf.

Portuguese Finance Minister Fernando Teixeira dos Santos called the auction a success, with 80 percent of the demand from overseas investors. But Leister said it remained to be seen whether this would be a turning point and whether this week's modest fall in borrowing costs could be sustained.

TRAUMATIC MEMORIES

The euro zone's two main powers, Germany and France, praised Portugal's austerity measures and said it needed to convince investors it was implementing reforms effectively to control its public finances and revive a stagnant economy.

The EFSF, created last May for euro zone countries that get shut out of bond markets, has a theoretical capacity of 440 billion euros ($570.3 billion) but can effectively only lend 250 billion euros because of cash buffers agreed to obtain a top notch credit rating.

Given traumatic memories of two IMF interventions since the 1974 revolution that overthrew Europe's longest-running dictatorship, Socialist Portuguese Prime Minister Jose Socrates is determined to avoid applying for aid if at all possible.

The issue has taken center-stage in Portugal's presidential election campaign with both of the main candidates for the January 23 ballot trying to use it to discredit the other.

Socrates, who heads a minority government dependent on opposition votes to pass legislation, has insisted his country is ahead of target in reducing its deficit and does not face the acute problems that drove Greece and Ireland to seek bailouts.

Optimism that a more effective EFSF may be in the works also helped reduce the risk premium investors demand to hold Spanish and Italian government bonds rather than benchmark German debt.

Belgium's caretaker prime minister said his government will aim for a budget deficit of less than 4.0 percent of gross domestic product this year, compared with the 4.7 percent forecast by the Belgian central bank.

High-debt Belgium has also come under bond market pressure due to its failure to form a new government since elections last June, prompting King Albert to ask the caretaker administration to devise new deficit-cutting measures in the meantime.

Euro zone sources told Reuters on Tuesday that the bloc's finance ministers were likely to consider next week the option of raising the effective lending capacity of the rescue fund as part of efforts to calm sovereign debt markets.

But sources cautioned that a firm decision was unlikely to be taken on Monday and any increase in lending capacity could be limited by the dual constraints of credit ratings and the need to avoid a new round of parliamentary approvals, particularly in Germany.

Europe's safety net is meant to buy time to allow heavily indebted governments to restore order in their public finances to make their debt burden manageable, but many economists believe Greece and Ireland will eventually have to restructure their debt, forcing losses on taxpayers and/or bond holders.

(Additional reporting by Ilona Wissenbach in Brussels, William James and Ben Hirschler in London, Axel Bugge and Sergio Goncalves in Lisbon; writing by Paul Taylor, editing by Mike Peacock and Patrick Graham)

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