December 15, 2017 / 11:15 AM / 6 months ago

UPDATE 1-Portuguese yields drop below Italy for 1st time in almost 8 years

* Trade through Italian peers for 1st time since early 2010

* Fitch Ratings to review Portugal

* Upgrade could see Portugal return to major bond indices (Writes through)

By Dhara Ranasinghe

LONDON, Dec 15 (Reuters) - Portuguese bond yields hit their lowest levels since early 2015 on Friday, pushing them briefly below Italian yields for the first time in almost eight years ahead of a potential ratings upgrade that could see Portugal return to major bond indices.

Fitch Ratings, which has Portugal on a BB+ grade with a positive outlook, is scheduled to deliver its latest verdict on the southern European state later on Friday.

After S&P Global on Sept. 15 lifted once bailed-out Portugal’s rating out of “junk” and into investment grade territory in September, investors have been anticipating a further upgrade that would allow Portugal to rejoin the big bond indexes.

Most major indexes, such as the Markit iBoxx euro benchmark index and the Bloomberg/Barclays euro aggregate index, use the average ratings of Moody’s, S&P and Fitch.

Inclusion in those indexes would expose Portugal to a wider pool of investors, who only buy the sovereign bonds of countries that have an investment grade rating from the main agencies.

“We think this is the final death throes of the rally in Portuguese bonds as people speculate about the ramifications of a ratings upgrade,” said Lyn Graham-Taylor, a fixed income strategist at Rabobank.

Portugal’s 10-year bond yield slid almost 8 basis points to 1.76 percent, its lowest level since April 2015. That briefly pushed yields below those on Italian counterparts for the first time since early 2010, according to Tradeweb data .

Portuguese bonds have been a star performer of the euro zone market this year thanks to stronger-than-expected economic growth and improvements in the country’s fiscal position.

“Portugal had an upgrade in its rating back in September, which helped the country attract foreign investors,” said Naeem Aslam, chief market analyst at Think Markets. “The country’s debt is in demand and it is clear when you see the yield on the 10-year bonds.”

In contrast, Italian bonds have come under pressure this week from reports that Italy could hold an election as early as March next year. One is due by May at the latest.

Elections look unlikely to produce a clear winner, unnerving investors who have piled out of Italian bonds this week — leaving yields on track for a weekly rise of around 12 bps, the biggest weekly jump since July.

In broad terms, euro zone bond yields were lower on Friday a day after the ECB stuck to its pledge to keep money pouring into the bloc’s economy for as long as need and wrangling over a U.S. tax bill supported demand for fixed income.

“The short-term driver of bonds is the doubts overnight about the backing of the U.S. tax bill,” said Mizuho rates strategist Antoine Bouvet. “Also we saw yesterday that the ECB does not expect inflation to rise too much.”

Reporting by Dhara Ranasinghe; editing by Sujata Rao and John Stonestreet

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