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UPDATE 1-Portugal returns to investment grade after 5-1/2 years

(Adds finance minister quotes)

LISBON, Sept 15 (Reuters) - Standard & Poor's on Friday became the first of the big three credit ratings agencies to lift Portugal back to investment grade, citing its improving economy and public finances.

Portugal lost the investment grade at the height of its debt crisis in January 2012.

The upgrade is likely to attract more portfolio investment in Portuguese debt at a time when the positive impact of the European Central Bank's asset-buying programme is subsiding.

"We now expect that the yield spreads with most European countries will narrow and this is very important, for investors too, as they look a lot at the spreads, sometimes more than at the actual yields," Finance Minister Mario Centeno told Reuters.

"We are now a lot more prepared for any future evolution of the monetary policy in Europe," he added.

The loss of the investment grade by the last of the Big Three in January 2012, also after an S&P move, made Portugal's benchmark 10-year bond yields blow out to a record of over 17 percent.

The yield has since come down to around 2.8 percent, helped by Portugal's own improvements and the ECB bond-buying, but it still is the second-highest in the euro zone after Greece's.

Standard & Poor's, which had rated the country at BB+ with a stable outlook, shifted its position by one notch to BBB-, the lowest investment grade mark, again with a stable outlook.

"While we view the high level of public and private sector indebtedness as a credit weakness, we observe that external financing risks have declined significantly," it said in a statement, projecting that the economy would grow by more than 2 percent on average in 2017-2020.

That is above S&P's previous forecast of 1.5 percent.

It also said it expected this year's budget deficit target of 1.5 percent of GDP to be met, "putting the government debt to GDP ratio on a more firmly declining path".

Lisbon last year churned out the lowest budget gap since 1975, and in June, the European Council ended a disciplinary process against Portugal, which only emerged from a three-year international bailout in 2014, over its excessive deficit.

Two weeks ago, Moody's Investor Service left Portugal's rating unchanged at Ba1, or one notch into speculative territory, but upgraded Portugal's outlook to positive from stable, which usually means an upgrade is on the cards. Fitch Ratings, another of the big three, did the same in June.

Canada's DBRS, a smaller credit ratings agency, has been the only rater recognised by the European Central Bank to maintain Portugal's rating at the lowest investment-grade level throughout its 2011-14 debt crisis and bailout.

The International Monetary Fund said earlier on Friday in a report that "a ratings upgrade would significantly expand the investor base for Portuguese sovereign debt and offset the impact of any further decline" in the support to the debt market provided via the ECB's programme, which is due to end this year.

Portugal endured years of painful austerity under the bailout, but the left-leaning Socialist government, in power since late 2015, has managed to combine budgetary discipline with a reversal of some of the austerity measures. (Reporting By Andrei Khalip; Editing by Gareth Jones and Jonathan Oatis)