Portuguese bonds underperform as Lisbon delays aid review
* Portugal requests aid review delay to August
* Lisbon wants time to resolve political crisis
* Irish bonds advance after S&P raises its ratings outlook
* Other euro zone bonds gain on Fed, ECB policy reassurances
By Emelia Sithole-Matarise
LONDON, July 12 (Reuters) - Portuguese government bonds underperformed other euro zone debt on Friday after Lisbon delayed its creditors' next review of the country's bailout due to its political crisis.
The country's debt bucked a firmer tone in the rest of the region's bond market after U.S. Federal Reserve President Ben Bernanke this week talked down expectations of tighter monetary policy and reassurances by the European Central Bank that interest rates would stay low while inflation was moderate.
Portugal's international lenders had been due to begin a review of the programme on Monday but the country asked for a delay until August after President Anibal Cavaco Silva rejected a plan to heal a government rift, throwing the country into political disarray.
Portuguese two-year yields rose 21 basis points to 5.98 percent while 10-year yields were up 12 bps at 7.10 percent, with little respite seen in the near term.
In contrast, and highlighting the divergence in bailed-out countries' fortunes, equivalent Irish yields fell 5 bps to 3.92 percent after Standard & Poor's raised the country's ratings outlook to positive from neutral, saying it may beat its fiscal targets.
The S&P move fueled expectations that Moody's, the only major rating agency that rates Irish sovereign debt as "junk', could at least take the country, which is on course to exit its bailout, off negative watch.
"Portugal is struggling as the government delays the next quarterly review ... which is clearly fueling fears that Portugal doesn't have the appetite for further fiscal consolidation measures in place," said Nick Stamenkovic, a rate strategist at RIA Capital Markets.
Shorter-dated Portuguese debt resumed their underperformance of longer-term bonds, pinching their yield gap to its narrowest in nearly 16 months at around 123 bps, as investors fret that Lisbon might have to restructure its debt in the future.
Sentiment in the rest of the euro zone was upbeat on the Fed and ECB rate outlooks, with Spanish 10-year yields down 11 bps at 4.71 percent while Italian equivalents were 4 bps lower at 4.46 percent.
Spanish bonds regained some ground over Italian peers after a sharp underperformance in the previous two sessions after an S&P ratings downgrade of Italy raised fears Spain might be next - which could see it lose investment-grade status.
Some market participants said the sell-off was overdone.
"While we see Spain as more vulnerable than Italy to further downgrades, we do not expect imminent rating actions that can take Spain out of the IG (investment grade indices)," Barclays Capital strategists said.
They pointed to the fact that S&P had only a month ago reaffirmed Spain's rating at BBB- and negative outlook. Fitch rates the country BBB with a negative outlook while Moody's has it on Baa3 also with a negative outlook.
"Therefore, for Spain to fall from the IG indices, they have to be downgraded by Fitch by two notches and also one notch by Moody's," the Barclays strategists said in a note.
At the euro zone's core, German Bund futures rose 41 ticks to 143.34 with the 10-year cash yield 3.3 bps down at 1.59 percent, tracking firmer U.S. Treasuries after a solid 30-year T-bond auction on Thursday.
"Bernanke devalued the tapering fears a little bit. I don't see any reason why we should sell off going into the weekend. The tone in the market is OK," one trader said.
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