* Euro zone inflation 0.5 pct in March, below forecast
* Peripheral yields stay near multi-year lows
* ECB expected to hold fire on Thursday, may ease later (Recasts and adds fresh comments)
By Marius Zaharia and John Geddie
LONDON, March 31 Lower-rated euro zone bond yields held near multi-year lows on Monday, as a drop in euro zone inflation kept speculation rife that the European Central Bank may loosen monetary policy further later this year.
Euro zone inflation slowed to 0.5 percent in March from 0.7 percent the previous month and compared with expectations of a 0.6 percent reading in a Reuters poll.
This did not convince market participants that the central bank will take immediate action at its meeting on Thursday, but keeps the pressure on the ECB to at least reinforce its accommodative policy stance.
"The numbers point to low (rates) for longer from the ECB, which is an environment in which the periphery should flourish because everybody is hunting for yield," said Marius Daheim, chief strategist at Bayerische Landesbank.
Italian 10-year yields were flat on the day at 3.31 percent, having hit an 8-1/2 year low of 3.261 percent on Friday. Spanish yields were also flat at 3.24 percent, just off an eight-year low of 3.20 percent.
Portuguese yields rose 2.5 bps to 4.07 percent, having dipped below 4 percent for the first time in four years on Friday. Irish yields were 5 bps off their record low of 2.974 percent.
Investors had already been positioned for a below-forecast figure after subdued inflation numbers from Spain and Germany on Friday and traders said some of them booked some profits after the release in a sign of caution before the ECB meeting.
"In our view, investors pinning hopes on further ECB easing on Thursday will likely be disappointed," said Michael Leister, senior interest rates strategist at Commerzbank, concurring with a Reuters poll that showed the ECB was not expected to take further action on Thursday.
Some traders also pointed to comments on Saturday by Bundesbank chief Jens Weidmann that the euro zone was not in a deflationary cycle and that the ECB should not over-react to a temporary slowdown in inflation.
Five-year, five-year forward breakeven rates, one of the ECB's favourite indicators of long-term inflation expectations, are quoted at 2.10 percent. A significant break below 2 percent would prompt action, said Alessandro Giansanti, senior rates strategist at ING.
"As long as medium- to long-term expectations stay firm then the ECB should not need to intervene," he said.
Money markets, the best gauge of expectations of what the ECB is likely to do, pointed to little chance the ECB would ease monetary policy on Thursday. Forward overnight euro zone bank-to-bank Eonia rates dated for April were 0.175 percent, only 2 bps below the spot Eonia rates.
Eonia rates dated October through December were around 0.13-0.14 percent, indicating that the market sees an increasing chance of ECB easing towards the end of the year.
"There's definitely some expectation that they will do something further down the line," ICAP strategist Philip Tyson said. "That sort of (inflation) number does keep the pressure on the ECB to act."
Low inflation has kept yields on top-rated debt anchored at low levels. German Bund yields, the benchmark for euro zone borrowing costs, rose 2 bps to 1.57 percent, having fallen to two-week lows of 1.51 percent on Friday. (Graphics by Natsuko Waki; Editing by Gareth Jones/Ruth Pitchford)