Greek yields fall again after aid lifeline approved
* Greece secures aid, keeping default threat at bay
* Risk remains as lenders opt for drip-feed approach
* Portuguese yields also fall after cabinet reshuffle
* Initial interest for Spanish 15-year debt tops 7 bln euros
LONDON, July 9 (Reuters) - Greek government bond yields fell for a second day on Tuesday after euro zone finance ministers approved an aid payment that will spare the country from default in August.
Portuguese yields also fell after the ruling coalition parties patched up a rift that had threatened Lisbon's plans to return to markets in 2014 and sent yields rocketing last week.
Greece outperformed after finance ministers approved a 6.8 billion euro deal under which Athens will be drip-fed support conditional upon implementation of reforms. 1/2ID:nL6N0FE1C3 3/8
Greek 10-year yields fell 20 basis points to 10.75 percent, having fallen more than 40 bps on Monday on expectations it would secure the aid payments.
"For Greek bonds it's positive so yields can drop further," said Mathias van der Jeugt, a strategist at KBC. He said a gradual fall in 10-year yields to just below 10 percent was possible in coming weeks if euro zone tensions remain subdued.
The Greek yield curve remains inverted, however, with 10-year bonds yielding more than longer-term debt, in a sign of the stress government financing is under.
Morgan Stanley strategists closed their buy recommendation on Greek bonds and shifted their stance to neutral, saying prices may come under pressure from potential political constraints to Athens meeting its bailout conditions against a backdrop of a repricing of risk premium globally.
"Greece still presents attractive medium-term potential value, but strong idiosyncratic drivers are necessary to restore a renewed momentum which would allow Greece to outperform other European peripherals," they said in a note.
Although the sell-off in Portuguese bonds eased, investors remain edgy over Lisbon's ability to exit its bailout.
The Portuguese president was expected to ratify a cabinet reshuffle that sees Paulo Portas, head of the CDS-PP party and a critic of the austerity that has pushed Portugal deeper into recession, become chief negotiator with Lisbon's lenders.
Portuguese two-year yields were 10 bps down at 5.60 percent while 10-year bonds yielded 6.94 percent, down 9 bps on the day.
Two-year bonds have yet to unwind last week's sharp underperformance of longer-term debt. The yield curve is at its flattest since April 2012, reflecting concern the country may have to restructure its debt in the future.
"KBC's van der Jeugt said investor hesitancy would see 10-yesar yields stay between 6 and 7 percent. "We first need to see how things work out after the cabinet reshuffle."
Italian and Spanish bonds bucked the fall in yields, weighed down by debt sales. Spain tested demand for a new 15-year bond via syndication, days after a 4 billion euro bond auction.
Demand for the bond was last indicated at 7.5 billion euros, according to Thomson Reuters news and financial service IFR, with pricing expected later in the day.
Calmer euro zone debt markets underpinned by the European Central Bank's pledge to keep interest rates low for an "extended" period supported the sale, analysts said.
"It's a good enough result and looks cheap on the curve and I think it will all be placed,' a trader said.
The ECB's ultra-easy policy also helped demand for safe-haven German Bunds, offsetting fallout from a rise in U.S. Treasury yields after jobs data last week strengthened the case for the Federal Reserve to reduce its stimulus later this year.
Bund futures were last 22 ticks up at 142.16 with cash yields 1.7 bps lower at 1.68 percent.