Euro zone bonds rise after Summers drops Fed candidacy
* Summers seen more hawkish than new frontrunner Yellen
* Bunds track Treasuries up, other euro zone bonds follow
* Portuguese bonds lag as bailout review gets underway
By Emelia Sithole-Matarise
LONDON, Sept 16 (Reuters) - Euro zone bond prices mostly rose on Monday after Lawrence Summers, widely seen by financial markets as less committed to ultra-loose monetary policy, withdrew from the race to head the U.S. Federal Reserve.
Top-rated Bunds led the charge, tracking U.S. Treasuries as investors bet Summers' withdrawal eased the risk of a Fed leadership that would rein in its programme of support for the economy faster next year than currently expected.
The other leading candidate to head the central bank, Fed deputy chief Janet Yellen, is seen by markets as likely to be more supportive of existing policy and less likely to scale bond purchases back quickly and raise rates.
Summers' decision comes just before the Fed meets this week to decide when and by how much to trim its asset purchases from the current pace of $85 billion a month.
"The timing of Summers' withdrawal took markets by surprise and and the rally in Treasuries has given a boost to Bunds and gilts," said RIA Capital Markets strategist Nick Stamenkovic.
"That clearly makes Janet Yellen front runner for new Fed chairman. She is known as a key supporter of QE and the market is taking the view that interest rates will be kept lower for longer."
The Bund future was last 40 ticks up at 138.39 with German 10-year yields down 3.5 basis points lower at 1.89 percent.
U.S. Treasuries outpaced their German counterparts, squeezing the 10-year T-note yield premium over Bunds by 5 bps to 87 bps.
German 10-year yields have pulled further away from a 1-1/2-year high of 2.059 percent hit on Sept. 6, as mixed U.S. economic data clouded the outlook on how fast the Fed would scale back its monetary stimulus.
Some in the market saw limited gains for top-rated bonds before the bank's decision on Wednesday.
"We continue to see support for the Bund with yields above 2 percent, while yields below 1.9 percent appear expensive amidst the tapering (of bond-buying) anxiety," Commerzbank strategists said in a note.
"We prefer to keep duration exposure limited as Wednesday's FOMC decision looks set to produce knee-jerk volatility."
At the other end of the credit spectrum, Italian 10-year yields were down 3 basis points at 4.54 percent and Spanish equivalents were 1 bps lower at 4.48 percent, with gains in the latter capped before debt sales later in the week.
Portuguese bonds bucked the trend as investors fretted about Lisbon's relationship with its international backers after the head of the group of euro zone finance ministers rejected any softening of the fiscal targets in its bailout deal.
Yields on its 10-year bonds edged up 4 bps to 7.49 percent, extending Friday's rise. Wrangling over the degree of austerity that Portugal should implement almost led to a government collapse in July triggered by new Deputy Prime Minister Paulo Portas.
Portas said last week he wanted to see an easing of budget deficit goals and for the first time will oversee talks with European Union and International Monetary Fund officials, who start a review of the bailout on Monday.