* Italy retail debt sale sets new record just over 22 bln euros
* Italy meets nearly 95 pct of its annual funding goal with sale
* ECB meeting looms
LONDON, Nov 6 (Reuters) - Italian bond yields held near five-month lows on Wednesday after record demand at a retail sale of inflation-linked bonds reduced the country's funding needs for the rest of the year.
Italy raised just over 22 billion euros with a sale of 4-year debt. It was the biggest single bond sale by a European government and prompted the Treasury to close it more than two days earlier than planned.
Elsewhere in the periphery, yields on junk-rated Portuguese bonds dropped to their lowest level in five months.
Italian 10-year yields were flat at 4.18 percent . They fell as far as 4.13 percent earlier, not far from five-month lows hit on Monday at 4.07 percent.
Ten-year Spanish bond yields were 1.8 basis points higher at 4.13 percent, having fallen to a six-month low on Monday of 3.961 percent after Fitch upgraded its ratings outlook.
"It's another blockbuster sale of this issuance," said Commerzbank strategist Michael Leister. "Overall it takes away a significant share of the funding pressure because now they have more freedom to reduce the conventional BTP issuance in other sectors of the curve."
The Treasury reached nearly 95 percent of its annual funding goal with the sale and analysts say the successful sale could allow it to cut auction sizes for the rest of the year.
This strong financial position and expectations the ECB could loosen monetary policy further are allowing Italy to fend off pressure from political tensions before a Senate vote on whether to expel ex-premier Silvio Berlusconi from parliament.
"It's still unclear which strategy they will adopt in Rome - if they are going to announce a modification of the issuance schedule or if they will treat this as a pre-funding for next year," Alessandro Tentori, global head of rates strategy at Citi said.
CENTRAL BANK WATCH
Expectations the European Central Bank could signal further monetary policy easing at its meeting on Thursday underpinned euro zone bonds earlier this week.
But some investors took profits on Tuesday, thinking the market had gotten ahead of itself and a media report on Wednesday that the ECB would not cut rates this week only reinforced that view.
Market News International reported that the ECB would avoid an imminent interest rate cut on Thursday, citing two "Eurosystem" sources.
German Bund futures settled 1 tick lower at 141.15, having risen as high as 141.44.
A Reuters poll showed only one of 24 traders surveyed expected the ECB to cut interest rates on Thursday.
Portuguese 10-year yields dropped 20 bps to 5.942 percent, the lowest since early June, albeit in an illiquid market which exaggerates price moves.
"(There is talk that) there has been a big fund buying it for the past 24 hours," one trader said, adding "it doesn't take much to move Portugal nowadays."
According to Filipe Silva, debt manager at Carregosa bank in Lisbon: "It appears to be more a continuation of the trend we've been seeing since last week with a general good demand for Portuguese debt."