* Italian, Spanish 5-yr yields at lowest in at least 20 years
* 10-yr Portugues yields at lowest in over 3-1/2 years
* Euro zone factory recovery strongest in 2 1/2 years
* German 5-year bond sale draws lackluster demand
LONDON, March 5 (Reuters) - Spanish and Italian five-year yields hit historical lows on Wednesday after new data reinforced signs the bloc's southern economies are strengthening, while signs of easing tension in Ukraine also boosted demand for periphery debt.
Euro zone private businesses enjoyed their fastest growth rate in over 2 1/2 years last month, Markit's composite purchasing managers' indexes (PMI) showed on Wednesday, as the bloc's services sector expanded faster than initially thought.
"Data were strong this morning," said Annalisa Piazza, an analyst at Newedge Strategy. "The better economic outlook could be convincing market dealers the euro zone crisis will be close to an end. There will be a normalisation of the process of growth within the euro zone."
The PMIs showed Italy and Spain, the euro zone's third- and fourth-biggest economies, both beat forecasts and came in above the 50 mark that separates growth from contraction. The readings strengthened investors' view that the economic recoveries in Spain and Italy, crucial to curb high debt levels, are gaining ground.
Spanish five-year yields were down 9 basis points at 1.86 percent, falling further below 2 percent, to their lowest in at least 20 years, according to Reuters data. Italian equivalents were also lower by 7 bps at 1.91 percent.
Yields on both countries' 10-year bonds dipped further to new eight-year lows. Italy and Spain's 10-year debt was yielding 3.37 percent and 3.36 percent respectively, their lowest since late 2005.
Some easing of tensions over Ukraine also helped demand for riskier assets, with yields for junk-rated 10-year Portuguese debt falling 12 basis points to their lowest in more than three and a half years.
"The key driver more broadly is the fact that the situation has not escalated geopolitically (in Ukraine), which is why you've had an ongoing improvement in risk assets," said RBS strategist Michael Michaelides.
Yields for ten-year Greek bonds hit 6.89 percent, the lowest in almost four years. Greek debt met some resistance late in the day after its government asked international lenders to exclude the issue of the expected capital shortfall for Greek banks, in a bid to overcome an impasse that has held up its latest bailout review.
LACKLUSTRE GERMAN DEBT SALE
German 10-year Bund yields, the benchmark for euro zone borrowing costs, were flat at 1.602 percent. So too were five-year German yields at 0.63 percent in the secondary market, after Berlin sold 3.27 billion euros of five-year bonds.
It drew bids worth 1.4 times the amount offered versus 1.7 at last month's sale. It was, however, better than last week's 30-year bond auction which was shunned by investors because of its low potential returns, and a 10-year debt sale the week before, which met similarly poor appetite.
Ahead of the European Central Bank's rate decision on Thursday, money markets showed little likelihood of further monetary policy easing from the ECB after slightly forecast-beating inflation data last week.
Many still expect the ECB to act later this year. Inflation is predicted to stay way below the central bank's target of below but close to 2 percent, potentially threatening the euro zone recovery.