Portuguese yields dip towards mid-2010 lows before debt buyback
* Portugal to buy back 2015 bonds
* Buyback is second such move so far this year
* Market calm before German court verdict on ESM
By Emelia Sithole-Matarise
LONDON, March 18 (Reuters) - Portuguese yields headed back towards four-year lows on Tuesday before a bond buyback aimed at fostering investor confidence that the country can fund itself after it exits its international bailout this year.
The rejection late on Monday by Portugal's opposition Socialists of an agreement with the government on a long-term plan to reduce the budget deficit was seen having little impact for now on demand for the country's bonds.
Taking advantage of investor demand for higher returns, Lisbon plans to buy back 2015 bonds in a reverse auction later in the day, the second such move this year aimed at easing its redemption burden.
Many in the market expect it to buy back up to 1 billion euros of the bonds, slightly less than the 1.32 billion euros of October 2014 and 2015 debt it repurchased last month.
Portuguese two-year yields slid 13 basis points to 1.36 percent while 10-year bonds yielded 5 bps less at 4.52 percent , heading back towards the four-year lows hit last week.
"All this (buyback activity) is a confidence building exercise, building on the momentum we have seen already," said Peter Goves, a strategist at Citi.
"In general the fundamental tone is improving. We've seen an array of positive news from rating agencies and everybody awaits Portugal to come back to the market and leave the troika (bailout) programme later in the year. That is the key event for Portugal."
Portugal's 78 billion euro bailout by the European Union and the International Monetary Fund expires in May and the bond repurchases are seen as a signal that it can stand on its own thereafter.
A CLEAN BREAK?
Questions remain, however, as to whether Portugal can make a clean break from the aid programme agreed in 2011 and do without a safety net, in the form of a precautionary credit line, in case it gets into financial trouble.
A refocus by investors on domestic politics, such as the Socialists' rejection of a post-bailout pact with the government on reducing the budget deficit, could prompt Lisbon to take a precautionary credit line, some strategists said.
"We would suggest that an exit associated with such a credit line could actually be viewed as a positive by the market - this being because it would be more likely to tie the government into ongoing reforms," Rabobank strategists said in a note.
Other euro zone bonds held steady, with market generally participants sanguine before a German Constitutional Court ruling on the legality of the euro zone's bailout fund, the European Stability Mechanism.
Many in the market believe the ruling is a 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 European Court, a move analysts said could lead to a more positive ruling for the plan widely credited with easing the euro zone debt crisis.