Portugal's central bank predicted the economy would shrink this year, painting a gloomier outlook just as the government sought on Tuesday to quash persistent talk of a bailout.

Prime Minister Jose Socrates told a news conference that Lisbon had no plans to seek aid after what he said were excellent budget execution results for 2010.

But the Bank of Portugal forecast the economy would shrink 1.3 percent this year as austerity measures crushed internal demand -- in sharp contrast to the government's projection that exports would help gross domestic product (GDP) to grow 0.2 percent.

The government, seeking to convince investors it does not need a bailout like Greece and Ireland, said it beat its 7.3 percent deficit target last year. A recession would threaten plans to slash the gap further to 4.6 percent of GDP this year.

On Monday a central bank official was quoted as saying Portugal would do better to seek international financing, breaking ranks with political leaders.

It would be easier if we had foreign help because this would mean that the adjustment would not be so abrupt, but if we do it alone, for the markets to believe in it, it has to be brutal, central bank board member Teodora Cardoso said according to news agency Lusa.

The premiums investors seek for buying Portuguese bonds over low-risk German Bunds fell on Tuesday, with traders citing European Central Bank buying, ahead of a sale on Wednesday that economists say could tip the balance in Portugal's battle to avoid a bailout.

Many economists have said the government's austerity drive will lead Portugal into a recession in 2011, and analysts from Barclays Capital said the contraction may have begun already at the end of last year.

Based on recent data for industrial production, construction output and retail sales ... our expectation that real GDP contracted in the fourth quarter by around 0.4 percent (quarter-on-quarter) is being borne out, they said in a note.

Socrates cited preliminary data as showing the budget deficit had ended 2010 below the 7.3 percent of GDP ratio promised to Brussels, meaning it had cut the deficit by more than 2 percentage points from 2009's highs.

The country is doing its work and is doing it well... Portugal is one of the countries in Europe that cut its deficit most in 2010, Socrates told reporters.

I'd like to point out that the Portuguese government and Portugal will not ask for any aid or financial assistance for the simple reason that it is not necessary.

Analysts said the budget execution news was positive if the government's figures are confirmed in late March.

Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said the news of a lower deficit was welcome but would have little impact on the government's efforts to avoid resorting to a bailout.

Portugal's fate has been out of its own hands for some time and even if the deficit was 3 or 4 percent, it would not change the situation.

Socrates said the country would keep financing itself in markets and was confident about Wednesday's bond offering of up to 1.25 billion euros.

This placement is going to run well, he said.

(Reporting by Shrikesh Laxmidas and Daniel Alvarenga, writing by Andrei Khalip; editing by Patrick Graham/Ruth Pitchford)

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