European shares pause; periphery outperforms again

* FTSEurofirst 300 up 0.1 pct, Euro STOXX 50 flat

* Madrid, Milan, Lisbon, Athens, Dublin bourses extend rally

* Massive trading volumes in periphery

* Euro zone banks up 6.4 pct so far in 2014

By Blaise Robinson

PARIS, Jan 8 (Reuters) - European stocks paused on Wednesday around 5-1/2 year highs, but rising confidence that peripheral euro zone economies are starting to recover from the region's debt crisis helped markets there extend a rally.

Trading volumes on Portugal's PSI 20 benchmark share index were seven times the daily average, while turnover on the main Madrid and Dublin indices were more than twice their daily averages, according to Thomson Reuters (Frankfurt: TOC.F - news) data.

Peripheral euro zone stocks have seen hefty inflows recently, as the economies hit hardest by the bloc's prolonged crisis begin to show signs of improvement.

Bumper demand for Ireland (Other OTC: IRLD - news) 's first bond sale since it exited its EU/IMF bailout helped push down euro zone government bond yields on Tuesday and lifted expectations that Portugal will be able to exit its EU/IMF bailout programme this year as planned.

The broad FTSEurofirst 300 index of top European shares ended 0.1 percent higher at 1,321.19, just shy of a 5-1/2 year high hit earlier in the session.

The euro zone's blue-chip Euro STOXX 50 index ended flat, while the UK's FTSE 100 index shed 0.5 percent, Germany's DAX index dipped 0.1 percent and France's CAC 40 ended down 0.04 percent.

The mood was brighter in the euro zone periphery, with Spain's IBEX gaining 0.7 percent, Portugal's PSI 20 up 1.4 percent, and Greece's ATG index adding 3.3 percent.

"Overall, things are improving in the euro zone. Spain's recovery is gaining traction as all the efforts the country has made are starting to pay off," said Claudia Panseri, head of equity strategy at Societe Generale Private Banking, which has 84 billion euros ($114 billion) of assets under management.

"We're particularly positive on the shares of euro zone banks that already meet Basel III capital ratios. They have already significantly reduced their leverage and strengthened their balance sheets."

The STOXX euro zone bank index gained 1.8 percent, extending its rally so far this year to 6.2 percent, about a quarter of its gains for the whole of 2013.

Spain's Banco Popular jumped 8.9 percent, Italy's Intesa Sanpaolo (Frankfurt: IES.F - news) rose 2.2 percent and Portugal's Millennium BCP gained 2.7 percent.

"It's all about the peripheral yields falling, that's what triggered the rally in equities. Investments are flowing in, which also explains why the euro remains so strong," said Global Equities' head of quantitative sales trading David Thebault.

Spanish 10-year bond yields hit new four-year lows of 3.78 percent on Wednesday after the Irish bond sale.

"This is all based on the anticipation of an economic recovery, but it will take a good six months to see if there's a turnaround in the real economy," Thebault added. "We're not there yet."

Five sessions into the new year, the FTSE 100 is down 0.4 percent, the DAX down 0.6 percent, and the CAC 40 down 0.8 percent. Meanwhile, the IBEX is up 3.4 percent, the MIB up 2.5 percent and the PSI 20 up 7.6 percent.