* Euro zone bonds buoyant after ECB signals could ease policy in June
* Spanish, Italian, Irish yields at all-time lows
* Portuguese yields lower after S&P boosts credit outlook
* Money market rates fall sharply (Updates prices, adds more comments, detail)
By Emelia Sithole-Matarise
LONDON, May 9 (Reuters) - Italian and Spanish borrowing costs fell to record lows on Friday in a broad-based rally in lower-rated euro zone bonds after the European Central Bank signalled it could deliver fresh monetary stimulus next month.
A Standard & Poor's upgrade of Portugal's credit outlook to stable from negative added to the positive sentiment and gave a further boost to Lisbon as it prepares to exit its internatinal bailout this month. Moody's is expected to at least follow suit after the market close while counterpart Fitch shifted its outlook to positive from negative last month.
The focus remained on the ECB after President Mario Draghi gave his clearest signal yet on Thursday that policymakers might act in June to stem slowing inflation and bolster a fragile economic recovery in the currency bloc. Spain and Italy, which two years ago were at the forefront of the euro zone debt crisis, badly need the recovery to gain traction to curb high debt levels.
Money market rates have tumbled, with the one-year Eonia rate - the most traded contract in the forward market - dropping to its lowest in a year on Friday as traders firmed up easing bets.
That gave fresh impetus to the rally in lower-rated bonds, which has been relentless this year after the ECB raised the prospect that it could embark on an asset purchase programme - quantitative easing - if inflation remained persistently low.
"The market is trading the ECB options, both of a rate cut in June and maybe further ahead of quantitative easing. That's why we are seeing the outperformance in non-core paper," said Alessandro Tentori, global head of rates strategy at Citi.
Yields on Italian, Spanish and Irish 10-year bonds hit record lows of 2.90 percent, 2.87 percent and 2.65 percent respectively, outperforming benchmark German Bunds.
This is the latest in a series of all-time low yields this week for the countries that were worst hit by a debt crisis which only started to ebb after the ECB pledged in mid-2012 to do whatever it took to save the euro.
Some in the market saw scope for more falls.
"There's been a rebuilding of positions in those markets (Italy and Spain) from investors who had been underweight them a long time but I don't think that process is entirely finished yet," said Sandra Holdsworth, investment manager at Kames Capital.
"Right now there's very little risk premium being attached to a recurrence of events of three years ago and I would concur that that does seem like a very small likelihood at the moment, but obviously we are alert to potential change."
Portuguese 10-year yields fell 2 basis points to 3.44 percent, the lowest since early 2006, after S&P lifted the country's credit outlook early on Friday. The yields are a far cry from peaks above 17 percent hit at the height of the debt crisis.
The move was largely expected by analysts and marks a big turnaround in sentiment for a country which was seen at risk of defaulting on its debt just two years ago.
Some market participants are becoming cautious after the rapid fall in yields.
"In the European periphery we remain invested in Portuguese and Slovenian government bonds," said Scott Thiel, head of European Global Bonds at Blackrock.
"However, given their significant spread compression to German Bund yields in recent weeks and in light of excessive market expectations for imminent quantitative easing in the euro zone, we have reduced these positions." (Editing by Catherine Evans and John Stonestreet)