UPDATE 2-Portuguese yields fall sharply on debt buyback plan
* Portugal plans to buy back October 2015 bonds on Tuesday
* Portuguese yields fall across the curve
* Other peripheral yields fall after soft inflation data
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, March 17 (Reuters) - Portuguese yields tumbled on Monday as a plan to buy back bonds maturing in 2015 increased investor confidence in Lisbon's chances of exiting its bailout programme this year.
Portugal's 78 billion euro bailout, agreed with the European Union and the International Monetary Fund in 2011, expires in May and buying back debt was seen as an indication of its ability to stand on its own feet.
Lisbon plans to buy back October 2015 bonds on Tuesday - the second such move this year after it repurchased 1.32 billion euros of October 2014 and October 2015 bonds last month in order to ease its redemption burden.
Portuguese two-year yields fell 17 basis points on the day to 1.54 percent, having hit a four-year low of 1.42 percent last week. Ten-year yields fell 12 bps to 4.52 percent, also close to four-year lows.
"The Portuguese treasury is trying to convince everybody that it's on its way to being able to fund itself. It's very good news and it's enough to lead to a continuation of the rally in Portuguese bonds," DZ Bank strategist Christian Lenk said.
"In terms of size, I would be surprised if the volume tomorrow would be larger than 1 billion (euros) because investors are obviously liking Portuguese bonds and a larger volume would be costly for the treasury."
About 5.6 billion euros remain outstanding in October 2014 bonds and some 8.2 billion in October 2015. A June 2014 bond worth 4.5 billion also matures soon.
Those figures do not look as challenging as they did at the height of the crisis, when Portuguese 10-year yields topped 17 percent. Portugal has already covered its 2014 funding needs after raising 6.25 billion euros from five- and 10-year bonds via syndication this year.
Better-than-expected economic growth figures and the government's pledge to maintain fiscal discipline has attracted healthier demand for its junk-rated bonds as well.
Foreign investors bought almost 90 percent of five-year bonds and almost three quarters of 10-year bonds at this year's sales. Demand came mainly from Britain, Scandinavia and the United States, data from the debt agency showed.
Worries remain that Portugal's constitutional court might prevent further reforms and some analysts expect Lisbon to seek a safety net, after the bailout, in the form of a precautionary credit line which it can tap if it gets into trouble.
Portuguese bonds outperformed all other euro zone debt apart from Greece, whose market is significantly less liquid and regularly sees larger price swings.
Spanish, Irish and Italian yields fell 2-3 bps after euro zone inflation data for February was revised lower to 0.7 percent from a 0.8 percent flash estimate - well below the European Central Bank's target of just less than 2 percent.
"The picture for ... inflation remains extremely tame and inflation expectations will continue to be closely watched by policymakers at the ECB," Annalisa Piazza, market economist at Newedge Strategy, said.
German 10-year Bund yields, the benchmark for euro zone borrowing costs, rose 2 bps to 1.57 percent after Sunday's Russian-backed referendum in Crimea passed without major violence, reducing demand for safe havens.
Investors also tip-toed back into riskier assets after Western powers slapped limited sanctions on officials from Russia and Ukraine. Sunday's Crimea vote came after Moscow effectively occupied the region after Ukrainian President Viktor Yanukovich was ousted.
The market showed little concern a day before the German Constitutional Court ruling on the legality of the euro zone's bailout fund, the European Stability Mechanism. Many in the market say Tuesday's ruling is a mere formality after a preliminary verdict by the same court in 2012 said the ESM did not violate German law and could go ahead, though it insisted on veto rights for the German parliament.
The court last month referred a complaint against the ECB's OMT bond-buying scheme to the Euroepan Court, a move analysts said could lead to a more positive ruling for the plan widely credited with easing the euro zone debt crisis.