After 200 kilometres of riding, including nine climbs (five Cat. 2, three Cat. 3 and one Cat. 1), Sanchez stole the show from the likes of Contador and team-mate David Lopez-Garcia.
The Caisse D'Epargne leader surged out of the trio of leading Spaniards in the final five kilometres to pull off a brilliant solo victory on a beautifully sunny day in the famous French coastal town.
Sanchez was part of a six-man escape group that rode at the front of the race for most of the day, but was the only one to survive the final descent from the Cat. 2 Col du Tanneron and an attack by Contador on the closing climb.
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With the help of his team-mate Lopez-Garcia, the Spaniard was able to drop Contador and take the biggest victory of his career 28 seconds in front of the main bunch.
"I'm very happy for the Caisse d'Epargne team who allowed me to go for this. I was feeling well on a type of tough and bumpy course which suits my qualities," said the 23-year-old Sanchez.
Thanks to bonus seconds Sanchez, who finished 13th overall in last year's race, moves to third in the general classification at 16 seconds behind Gerolsteiner's Rebellin, who finished on the Paris-Nice podium in 2003 and 2004.
With three category one climbs in Sunday's final stage in Nice the yellow jersey could be decided on the Promenade des Anglais.
"I'm tired but then everybody else is. I expect more attacks from Contador and his Discovery Channel team tomorrow, but hopefully I can cope," Rebellin said after the stage.
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