I was sitting, hungover, in a sauna full of naked men and women taking part in a Japanese ritual, while a guy clad only in a towel banged gongs, sprayed water and burned incense. It was the morning after a protracted night of drinking, walking and discovering and as I sweated off the alcohol in this stylish Asian-themed sauna in a sprawling spa resort.

This wouldn't be unusual in Bangkok, or even Berlin, but my hedonistic destination of choice was one of Europe's least-known capitals, Luxembourg City. The tiny independent sovereign state is quietly attempting to join the list of European short-break destinations. And why not? It has more Michelin stars per head than any other European country, and the high proportion of foreign residents and visitors ensures a cosmopolitan atmosphere.

There's a surprising number of stylish places to stay, eat and party and the compact city of less than 90,000 people is gently nudging things along with a new policy of free entry to its nightclubs and bars. There is also a novel way of getting home at the end of the night: a minibus that serves as a cross between a bus and taxi, Nightrider (+352 9007 1010, nightrider.lu) operates from 6pm till 5am on Friday and Saturday nights and will pick you up and drop you to your door for a fraction of the price of a taxi (from €3 a head for a party of four).

You can also still smoke indoors, which may be enough of a draw for some – it certainly creates a decadent atmosphere in these strait-laced times.

The heart of Luxembourg City is essentially a giant old fortress, a plateau protected by sheer cliffs. Much of it is pedestrianised and Place d'Armes, the square in the heart of town, is a good place to orient yourself. The old town is chocolate boxy and upscale, and the main square is overlooked by a new, staggeringly opulent, designer hotel – Hotel Le Place d'Armes (hotel-leplacedarmes.com, doubles from €320).

But I was really visiting the city to test what the nightlife has to offer. The old town was the obvious place to start, and I persuaded Brian, an Irish journalist and long-time resident, to show me around. Urban City (6 rue de la Boucherie, urban.lu) is a popular drinking spot near the Ducal palace, crammed with multilingual natives and work-hard-play-hard expats.

After a pint or two, we left in search of more space and quiet. We eschewed the old town's glitzy clubs and bars and headed for the Grund, a warren of narrow streets on the banks of the Alzette river. With the old town and the cliffs illuminated, it was as atmospheric as Prague with a hint of Paris's Left Bank.

Café Des Artistes (22 Montée du Grund), slightly above the Grund, is an intimate bar with an old piano and a languid atmosphere that apparently (although not the night we were there) bursts into spontaneous sessions of whatever is the Luxembourgish equivalent of chanson. It was a great place to people-watch thanks to the bohemian crowd and some bottles of local beer.

Grund is also home to Mosconi, which has two Michelin stars (13 rue Munster, +352 54 6994, mosconi.lu). Its pasta tasting menu (eight courses, €72) looked tempting but the prices were strictly expense account-only. From the Grund, it was a short but hilly stroll to Rives de Clausen (rue Emile Mousel, rivesdeclausen.eu). This recently converted brewery has become a major nightlife centre, with a host of bars, restaurants and clubs thronged with Luxembourg's young and beautiful people. In complete contrast, round the corner is the homely restaurant Mousel's Cantine (46 Montée de Clausen, +352 47 0198, mouselscantine.lu, mains €17-€25), which serves comforting Luxembourgish specialities such as judd mat gaardebounen (smoked collar of pork with broad beans, €19.50).

Rue de Hollerich, a short cab ride away in the south of the city, is the home of the edgier end of Luxembourg nightlife. At numbers 42-44, bars and nightspots are clustered around a small courtyard. We started in The Lab, which is where things began to get blurry. It had a long, dark bar with fluorescent green lighting and a medical theme, with shots in test tubes and oxygen on tap. It was a few steps across the courtyard to Decibel (decibel.lu), a rock bar with friendly Irish owners and draught Guinness.

While Luxembourg is by no means a Berlin-style nest of debauchery, the city's small size, safety and beauty makes it ideal for nocturnal wandering from venue to venue. But perhaps it's the sheer number of foreigners in the city (37% of the country's population are immigrants) that makes it welcoming to the casual visitor. On our night out, Brian and I fell into conversations with strangers everywhere we went.

I recovered the next day at Domaine Thermal (+352 2366 6666, mondorf.lu), a 20-minute bus ride from the city in Mondorf-les-Bains. The spa has an outdoor-indoor thermal mineral bath heated to a blissful 36C. You can't wallow for too long – 20 minutes maximum is recommended – but there is a complex of saunas (which is where the previously mentioned nudity and gong banging took place), steam rooms and even more pools. At €32, day membership for the spa is great value.

Luxembourg City has some formidable tourist attractions, such as the Casemates du Bock, a warren of defensive tunnels dug into the rock, and the futuristic Mudam art museum (mudam.lu). But the countryside was calling and I spent my last day touring the gently rolling hills of the Ardennes, a 45-minute drive to the north, with a friend. We ended up in the otherwise unremarkable village of Redange, which has been put on the map by a thriving music venue. L'Inouï Café-Theatre (67 Grand-Rue, Redange, +352 2662 0231, inoui.lu) is firmly part of the European jazz circuit and is the heart of a mini-empire, publishing a magazine and hosting a theatre school.

It's this incongruity that makes Luxembourg so appealing. A few hedonistic days in the Grand Duchy will overturn the stereotype of a boring country of bankers and Eurocrats. Here you can have an unusual party weekend, with great food and post-party pampering, in a city that is easier to navigate than Paris or Berlin.

• Ryanair (ryanair.com) flies from Stansted to Frankfurt Hahn from £14 return, then get a shuttle bus (flibco.com) to Luxembourg City, from €10 return. Train fares (raileurope.co.uk) from London cost from £137 return. For a budget stay, the Luxembourg City youth hostel (+352 2268 8920, youthhostels.lu) is modern and comfortable (beds from €19.90)