UPDATE 3-Portugal bonds gain as Lisbon holds crisis talks
* Investors remain nervous before July 21 Portugal deadline
* Spanish debt market shrug off growing political tensions
* German Bunds rise after below-forecast German ZEW data
* Focus turning to Bernanke testimony Wednesday, Thursday
LONDON, July 16 (Reuters) - Portuguese government bonds firmed in thin trade on Tuesday as political parties sought agreement on austerity required under the country's bailout deal, with investors anxious further aid may be needed.
President Anibal Cavaco Silva last week rejected the premier's bid to heal a rift in the ruling coalition via a cabinet reshuffle, calling for a cross-party deal to last until the end of the international aid programme in June 2014.
The three main parties have promised to conclude talks by Sunday, gaining some respite from markets. A no confidence vote against Prime Minister Petro Passos Coelho on Thursday, called by the small Green Party, is seen unlikely to succeed.
Investors fear a prolonged crisis could force Portugal to seek a second bailout, in which official creditors may want to share the burden with the private sector and request a wider debt restructuring involving bond haircuts.
Five-year yields fell 21 basis points to 7.05 percent while 10-year yields were down 10 bps at 7.30 percent, retreating from highs near 8 percent hit last week after Lisbon delayed a review of its bailout due to the crisis.
Although five-year bonds recouped some of last week's losses, the 5/10-year yield gap was near its narrowest since June 2012, reflecting elevated credit risk.
"Everybody knows it is an unthankful job to execute a troika programme and at least they are trying to find a solution, that's why you see yields lower today," Commerzbank rate strategist David Schnautz said.
"But the shape of the curve is a classic stress signal and shows you that the bigger picture hasn't changed."
At about 3 cents in the euro, the gap between the price buyers offered for 10-year bonds and the price sellers wanted to be paid, indicated extremely low volumes. In Italy, the gap was 30 times smaller.
ON BERNANKE WATCH
Most other euro zone bonds firmed, with the Bund future rising 37 ticks to 143.76 on the back of an unexpected fall in German investor and analyst sentiment in July, reflecting economic tension in the bloc.
The Spanish debt market shrugged off pressure on Prime Minister Mariano Rajoy over a party financing scandal. Rajoy on Monday rejected opposition calls for him to quit and said his reform plans would not be held back.
Any euro zone bond gains were seen limited before Federal Reserve Chairman Ben Bernanke's semi-annual congressional testimony on Wednesday and Thursday. In recent months, strong comments on scaling back asset purchases were followed by softer ones, sparking some confusion among investors.
Cosimo Marasciulo, head of government bonds and FX at Pionner Investments, sold peripheral debt after Bernanke's first comments on reducing stimulus in May. Now he sees opportunities in the market but is reluctant to buy back the bonds.
"The next step will be to go long on credit and peripherals again but we are not there yet. At the moment we feel that there are some communication issues from the Fed. We are not sure about what the Fed will do," Marasciulo said.