(Adds comments, updates prices)
By John Geddie
LONDON, April 22 Portuguese debt yields held just above eight-year lows on Tuesday as Lisbon prepared to auction bonds this week, the first auction in three years.
Wednesday's 750 million-euro sale of 10-year bonds, which will follow a series of syndicated bond offerings since early 2013, will help show that the country can finance itself after its planned exit from an EU/IMF bailout on May 17.
"It is part of Portugal's long road back to becoming full market participants," said Luca Jellinek, a credit strategist at Credit Agricole. A strong auction should pull down borrowing costs in Portugal and the rest of the euro zone periphery, he said.
Portuguese 10-year bond yields dipped 1 basis point to 3.73 percent early on Tuesday. It pared those gains as the morning progressed, but yields still hovered just above eight-year lows of 3.66 percent reached last week.
Other peripheral bond markets also edged back towards multi-year lows, tightening the gap with core markets, which came under some early selling pressure.
German 10-year yields - the euro zone benchmark - opened 2 basis points higher at 1.53 percent. The Greek equivalents, meanwhile, were the best performers dropping 10bp to sit just above four-year lows at 5.98 percent.
Traders said speculation that the European Central Bank will begin an asset purchase programme to ease deflationary pressure in the euro area was buoying appetite for riskier assets, outweighing concerns that an international agreement to avert wider conflict in Ukraine was faltering.
The latest health check of the euro zone's manufacturing and services sector - April flash PMIs released on Wednesday - will be closely watched for clues of any potential ECB action.
Portugal's prospects for accessing funding in the markets were "very promising", said the IMF's mission chief for the country, Subir Lall, after Portugal passed the latest review of its bailout programme.
The IMF praised Portugal's efforts to narrow its budget deficit, but high unemployment and lagging competitiveness in exports are still holding back its recovery. Those issues have not dulled demand for its debt, however, as investors hunting for higher returns in an environment of low official rates.
"It seems to me that investors are quite willing to finance governments that have enormous structural problems nowadays," said Stephen Lewis, chief economist at Monument Securities.
Portugal's bailout is due to end on May 17, and attention now turns to whether it will request a credit line to support its post-bailout debt-market funding. The IMF said the country's debt outlook "remains fragile" but made no mention of any need for a precautionary loan.
Portugal will also be hoping its return to normal market funding will help persuade ratings agencies to pull it out of junk territory.
Fitch raised the outlook on Portugal's BB+ rating to positive from negative at the beginning of last month, raising the chances that the country will be lifted the one notch it needs to regain investment grade status.
Moody's and Standard and Poor's, which rate Portugal three and two notches below investment grade respectively, are scheduled to review the country on May 9.
"I do believe we have turned the corner in terms of ratings. We are now in an upgrade cycle rather than a downgrade cycle," said Peter Schaffrik, head of European rates and economics research at RBC. (Editing by Larry King)