* Fiscal cliff optimism, better German data improve mood * Lower-rated debt rallies, Portuguese yields below 7 pct * Greek debt rally on ECB collateral move By Marius Zaharia and Ana Nicolaci da Costa LONDON, Dec 19 (Reuters) - Greek government bonds rallied on Wednesday after a rating upgrade and a move by the European Central Bank to allow the paper to be used as collateral for its funding again. Better German data and optimism on the U.S. fiscal outlook increased the appetite for high-yielding assets, boosting Spanish and Italian debt and pushing Portuguese 10-year yields below 7 percent for the first time since February 2011. By far the best performer, though, was Greece. Standard & Poor's upgraded the country's sovereign rating to B-minus from selective default late on Tuesday, while the European Central Bank said on Wednesday that Greek debt will again be eligible as collateral at its funding operations. That should make the paper more attractive for domestic banks. The yield on Greece's 2023 bond fell about a point and a half on the day, to as little as 11.357 percent, the lowest since the bond was issued as part of a debt restructuring in March. The current yield level is just over a third what it was in early June when fears of a Greek exit were most intense. "The chance of Greece leaving (the euro zone) has diminished," said Alan McQuaid, chief economist at Merrion Stockbrokers in Dublin. "The euro zone is slowly moving in a direction where it is clearer that it's not going to blow up." "Going back to (President Mario) Draghi's comments that (the ECB) will do whatever it takes to save the euro, there seem to be more and more people believing that's going to be the case." Easing Greek exit fears, as well as a track record of sticking to the terms of a painful bailout deal, have helped Portuguese debt rally massively this year as well. Portuguese 10-year yields fell 13 basis points on the day to 6.90 percent, having traded above 17 percent at the start of the year. Spanish and Italian benchmark yields have dropped by 1-2 percentage points since Draghi's late July comments, which were followed by the announcement the ECB would buy bonds of countries seeking help from the euro zone's rescue fund. Yields on 10-year Spanish bonds were 6 bps lower on the day at 5.27 percent and the Italian equivalent fell 7 bps to 4.39 percent. "I would recommend to buy Spain on the front of the curve, both outright or versus Italy," said Sergio Capaldi, fixed income strategist at Intesa SanPaolo. "It's a one way bet." That's because if you think Madrid will need a bailout, you would have to price in central bank support, while any optimism on Spain would likely benefit that part of the curve most, he said. BUNDS FALL German Bunds were down 20 ticks on the day at 144.21, maintaining their falling trend seen in recent sessions. Their safe-haven appeal faded after a survey from the Munich-based Ifo think tank showed morale at German businesses climbed in December as their confidence in the outlook rose at its fastest rate in 2-1/2 years.. Hopes of a U.S. budget accord rose this week after President Barack Obama made a concession, offering to limit tax increases to incomes exceeding $400,000 per household - a higher threshold than the $250,000 he had sought earlier. Despite the apparent improvement in risk appetite, though, losses for Bunds were seen limited. In the case of a deal, Bunds would "knee-jerk down but I don't see why we are going to collapse on it. I don't think that's the only reason Bunds have been reasonably well bid recently," a trader said. "The growth outlook in Europe looks awful and those forecasts are presumably based on the fiscal cliff getting sorted out."