Euro zone bonds surge after U.S. Fed keeps stimulus unchanged
* German yields see biggest one-day fall since August 2012
* S&P rating warning limits Portuguese yield fall
By Emelia Sithole-Matarise
LONDON, Sept 19 (Reuters) - Euro zone bond prices jumped across the board on Thursday after the U.S. Federal Reserve surprised financial markets by sticking with its $85 billion per month bond-purchase programme.
Citing strains in the economy from tight fiscal policy, the Fed decided against scaling back its monetary stimulus. Investors had been expecting the central bank to start reducing the size of purchases after its policy meeting on Wednesday.
Euro zone bond yields fell across the credit spectrum after U.S. Treasury yields dropped in the wake of the Fed decision. Global equities rallied as the prospect of ultra-loose policy for longer than initially thought spurred investor appetite for riskier assets.
Bond yields had been dragged higher in recent weeks by Treasuries on the prospect of reduced Fed purchases of benchmark U.S. debt.
"The punchbowl is again being refilled by the Fed and so everybody is very happy. That's why we saw equities rallying and bond yields falling," said Piet Lammens, a strategist at KBC in Brussels.
The Bund future rose 153 ticks to 139.35, its highest in two weeks, while cash German 10-year yields were down 13 basis points and on track for their biggest one-day drop since August 2012, at 1.82 percent.
In line with other risky assets, prices for lower-rated Italian bonds rose, pushing 10-year yields down 16 bps to 4.23 percent while Spanish equivalents were 15 bps lower at 4.24 percent.
Italian yields extended this week's fall on easing political tensions as former premier Silvio Berlusconi stepped back from threats to topple the government if lawmakers expel him from parliament after a tax fraud conviction.
Berlusconi, in a video message late on Wednesday shortly before a Senate committee took a first step towards expelling him, vowed to stay at the centre of Italian politics.
Portuguese yields fell a modest 5 bps to 7.17 percent, with further moves constrained after Standard & Poor's warned it could downgrade the country's credit rating. It cited constitutional court challenges to spending cuts and doubts about Lisbon's return to markets.
"We would continue to avoid Portuguese government bonds,despite the high yields and a friendly Fed," Societe Generale strategists said in a note.