Portuguese yields spike as crisis deepens
* Portuguese, Irish fortunes diverge as Lisbon thrown into crisis
* Portugal requests aid review delay to August
* S&P raises Irish ratings outlook, debt appeal
By Ana Nicolaci da Costa and Emelia Sithole-Matarise
LONDON, July 12 (Reuters) - Portuguese yields climbed on Friday after Lisbon delayed its creditors' next review of the country's bailout due to a political crisis, but other euro zone borrowing costs fell.
Portuguese debt lagged that issued by bailed-out peer Ireland, whose yields fell after Standard & Poor's upgraded the country's ratings outlook, highlighting their diverging fortunes and accentuating investor differentiation between their bonds.
Lisbon's international lenders were due to begin a review of the programme on Monday but the country asked for a delay until late August as the political crisis deepened.
The opposition Socialists demanded a renegotiation of Portugal's bailout terms, raising a hurdle to a cross-party pact the president says is needed to end the country's dependence on international funding next year.
Shorter-dated Portuguese yields rose faster than longer ones as investors priced in growing credit risk, while the moves were exacerbated by thin liquidity in Portuguese debt markets.
"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.
Portuguese 10-year yields climbed 56 basis points on the day to 7.53 percent while five-year yields rose 78 bps to 7.33 percent.
The gap between five- and ten-year Portuguese yields narrowed to 23 basis points - its lowest since July last year - and taking coming closer to an inversion in the yield curve.
Normally, longer-dated bonds offer comfortably higher returns than short-dated ones to compensate for the risk of holding an asset for a long time.
In a sign of scarce liquidity, the difference between the yield implied by prices buyers offered and those sellers wanted to be paid for Portuguese 10-year bonds was at 3 cents to the euro - its highest since August last year. The Italian equivalent was at 0.1 cents to the euro.
Ten-year Irish yields fell as far as 3.83 percent, and its gap versus equivalent Portuguese yields hit its widest since November. Irish yields were down 4.9 bps at 3.92 percent.
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.
Other peripheral markets also remained resilient to the sell-off in Portuguese debt as investors still had faith on the ECB's bond-buying backstop and domestic investors' willingness to support Italian and Spanish debt markets.
Demand for other euro zone debt also firmed after U.S. Federal Reserve President Ben Bernanke this week talked down expectations of imminent stimulus withdrawal and reassurances by the ECB that interest rates would stay low while inflation was moderate.
"I don't think we should have a lot of contagion coming from Portugal. This is a very specific story," Cyril Regnat, fixed income strategist at Natixis said.
Spanish 10-year yields were down 6 bps at 4.75 percent, recouping some of the ground lost versus Italy, whose yields were 1.2 bps lower at 4.48 percent.
An Italian ratings downgrade this week hurt Spanish debt particularly hard as investors feared more rating cuts could be coming. At just one notch above junk, Spain is most at risk of facing forced selling by investors who track benchmark bond indexes with minimum rating rules.
At the euro zone's core, German Bund futures rose 71 ticks to 143.64, pushing 10-year German yields lower.