* Greece returns to bond markets, ends four-year exile
* Investors snapping up 3 billon euros of 5-year bonds
* Further sign that euro zone may be exiting debt crisis
* Greece sees sale as first step to end austerity, bailout
* Real economy remains bleak, politics toxic
LONDON/ATHENS, April 10 (IFR) - Two years after it nearly crashed out of the euro zone, Greece returned to the bond market on Thursday with yield-hungry investors rushing to buy its debt in a 3-billion euro deal that could mark the beginning of the end of its bailout.
Athens offered a yield of just 4.95 percent to sell five-year bonds, the second lowest borrowing costs for a bailed-out euro zone state returning to market.
The bond, the first since its EU/IMF bailout began four years ago, attracted more than 20 billion euros of interest from over 550 investors, including 1.3 billion from lead managers.
The Greek bond is attractive to investors because it offers a relatively high return in an era of ultra-low interest rates. Expectations that the European Central Bank will take further steps to boost the euro zone economy are also fuelling appetite for bonds issued by the bloc's riskier countries.
Greece's government said the sale marked the beginning of the end of the tough austerity linked with its 237-billion euro bailout, which pushed unemployment to a record 27.5 percent and wiped out almost a quarter of the economy.
"Greece is leaving the bailout and the crisis behind," deputy Prime Minister Evangelos Venizelos told reporters.
The country's creditors also welcomed the move, saying it vindicated the tough economic policies endured by Greece and would bolster sentiment throughout Europe.
"It's extremely good news... and it will reinforce confidence in Europe to overcome the crisis," European Competition Commissioner Joaquin Almunia told reporters.
Greece is the third bailed-out euro zone country to return to the markets after Ireland and Portugal. Its borrowing costs, however, remain the highest in the euro zone.
Its solid market return buoyed sentiment in other peripheral bond markets on Thursday, driving their borrowing costs back towards multi-year lows.
Irish, Spanish and Italian 10-year yields were all 5 basis points down on the day at 2.90 percent, 3.16 and 3.15 percent A respectively.
An Irish sale of 1 billion euros of 10-year bonds also drew solid demand at a yield of 2.917 percent at its second regular auction since exiting its bailout in December. 1/8ID: nL6N0N220V 3/8
Athens considers the sale as part of gradual return to markets. It does not expect to cover all its funding needs from investors before 2016.
The bond's success is a result of the low-yield environment as investors cast aside memories of the 130 billion euros of losses Greece inflicted on private bondholders two years ago.
"Yields everywhere have been falling, and so, like in many asset classes, investors will be getting paid something for the risk that they are taking, but that risk premium is probably below historical levels for a commensurate risk," said Colm D'Rosario, senior portfolio manager, emerging markets and high yield, at Pioneer Investments.
The deal is seen by some investors as the culmination of an impressive recovery and restructuring story. One portfolio manager based in London said it is still quite wide compared to Portugal and that the spread will tighten further.
Greece's debt currently stands at about 320 billion euros, or 175 percent of GDP. It is rated nine notches below investment grade at Caa3 by Moody's. Standard and Poor's and Fitch rank Greece six notches below investment grade at B-.
But despite its size, the country's debt is attractive to investors because the 2012 restructuring has made it sustainable for ten years, the head of euro zone rescue fund ESM Klaus Regling said on Saturday.
"The bond issue proves the debt is sustainable, otherwise the markets wouldn't have bought it," Venizelos said.
Greece is rated nine notches below investment grade, at Caa3, by Moody's. Standard and Poor's and Fitch rank Greece six notches below investment grade, at B-.
About 85 percent of Greece's debt is in the hands of the European Union and the International Monetary Fund, at very low interest rates and on a long repayment schedule. Private creditors are holding just about 30 billion euros of bonds with maturities between 10 and 30 years.
POLITICS IN CRISIS MODE
But a dawn explosion in central Athens on Thursday served as a reminder of how fragile the country's politics and society remain after six years of recession, Greece's deepest peace-time economic slump ever.
In the biggest bomb explosion the city has seen in years, a booby-trapped car detonated on a street between a central bank building and the headquarters of Piraeus Bank, the country's second-biggest lender.
No-one has yet claimed responsibility for the attack, which caused material damages but no injuries and which police believe was carried out by leftist or anarchist guerrilla groups.
The blast happened a stone's throw away from the finance ministry and the hotel in which German Chancellor Angela Merkel will hold meetings in an official visit on Friday.
Anti-bailout groups and parties are preparing rallies on Friday to decry the austerity policies supported by Germany, Greece's biggest creditor.
Labour unions held a strike on Wednesday to protest at the government's economic policies and demand an end to austerity.
Jobless data released on Thursday showed the unemployment rate stubbornly high at 26.7 percent in January, even though it dropped to its lowest level in 11 months.
Greeks have seen their real disposable income fall by about 40 percent over the past six years, there has been a wave of corporate bankruptcies, and suicides have jumped by a third from pre-crisis level, causing the opposition to speak of a "humanitarian crisis" in the country.
The fragile coalition government of Prime Minister Antonis Samaras has just a two-seat majority in parliament.
The anti-bailout, leftist Syriza party, which has a slight lead in the polls, has accused Samaras of using the bond sale to score political points before European elections in May.
(Additional reporting by Costas Pitas and Renee Maltezou in Athens and Emelia Sithole-Matarise in London; Editing by Alex Chambers, Philip Wright and Giles Elgood)