Portugal yields dip after president rules out snap election
* Portugal parties fail to reach "national salvation" pact
* President supports coalition; bond rally seen capped
* Italian, Spanish yields slip as supply pressure eases
By Emelia Sithole-Matarise
LONDON, July 22 (Reuters) - Portugal's bond yields dipped on Monday after its president ruled out a snap election following the collapse of talks among the three main political parties on a deal to support the country's international bailout.
President Anibal Cavaco Silva said on Sunday he wanted the ruling centre-right coalition to stay in place to keep the rescue programme on track. Cavaco Silva had demanded a "national salvation" pact to see the 78 billion euro bailout through to its scheduled conclusion next year, after a rift within the ruling coalition threatened to derail it.
Talks between the coalition and the opposition Socialists, who want the aid deal renegotiated, collapsed on Friday.
Portuguese 10-year yields fell 15 basis points to 6.78 percent, extending last week's retreat from near 8 percent, on relief the country had avoided fresh elections that could have prolonged political uncertainty.
"The president who caused the most upheaval threw his support behind the current government, and in the short term this is slightly positive for Portuguese bonds as this support for the coalition is better for market stability than the alternative," said KBC strategist Mathias van der Jeugt.
Market participants saw limited scope for the yields to fall much further, however, as investors fret that the fragile coalition could struggle to steer the country out of the rescue programme in 2014 as planned.
A failure to issue new debt could force Lisbon to request another bailout, a burden investors fear official creditors may not be willing to carry alone, raising the possibility of a Greek-style debt restructuring.
The yield gap between Portugal's 10- and five-year bonds remained near its lowest in a year, suggesting investors were still worried about the country's credit quality.
"This maintenance of the status quo does nothing to address the divergences of opinion within the ruling coalition which are likely to return to the fore before too long," Rabobank strategists said in a note.
"Consequently, it would be wrong to take this morning's relief rally in Portuguese government bonds as signalling the all-clear in terms of Portuguese political risk and the threat this represents regarding the potential need for additional official creditor support."
In other lower-rated euro zone debt, Italian and Spanish bond yields were slightly lower, as supply pressure eases as the northern hemisphere summer holiday gets under way.
Spanish yields were last down 3 bps at 4.62 percent, with investors still little fazed by mounting pressure on Prime Minister Mariano Rajoy to explain his stance on a funding scandal that has hit his party. The Italian equivalent was 2 bps lower at 4.39 percent.
German Bunds held steady with investors wary of putting on big bets ahead of euro zone manufacturing activity and German IFO business sentiment data later in the week.
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