* Peripheral yields hit new multi-year lows on ECB speculation
* Five-year bonds outperform their two- and 10-year peers
* Money markets also point to ECB easing expectations
(Updates prices, adds fresh comments)
LONDON, March 27 (Reuters) - Spanish, Italian and Portuguese bond yields hit new historical lows on Thursday, with speculation about further European Central Bank monetary policy easing prompting investors to seek higher returns in lower-rated assets.
As the Federal Reserve in the United States signals an eventual turnaround in its ultra-loose monetary policy, ECB policymakers have left the door open to extraordinary measures if deflation risks in the euro zone pick up.
The ECB's policy bias has been a major driver behind this year's rally in peripheral bonds, which have outperformed German Bunds and U.S. Treasuries, the world's main benchmarks for borrowing costs. Yields have fallen to pre-crisis levels even in Greece, where the European sovereign debt crisis erupted in 2010 and culminated in Athens defaulting on its debt two years ago.
The latest trigger for speculation on what the ECB might do next came unexpectedly from Germany, whose policymakers have repeatedly voiced concerns about unorthodox monetary easing.
ECB Governing Council member and Bundesbank chief Jens Weidmann said earlier this week negative interest rates were an option to temper euro strength and buying loans and other assets from banks to support the bloc was not out of the question.
"It's obvious that the comments from the ECB have been fuelling expectations of the ECB doing more going forward ... and the fact that they are coming from Weidmann gives a bit more weight," said Jussi Hiljanen, chief fixed income strategist at SEB in Stockholm.
While the euro currency has already ceased to fall and stock markets have stabilised, bond traders said the ECB's comments simply gave investors another reason to keep buying peripheral debt, already in high demand since the start of the year.
Any further ECB easing would at least anchor yields on top-rated debt at ultra-low levels so investors chasing yield would be forced to look down the rating scale. The central bank meets next Thursday.
"The market has started to position for some form of ECB intervention next week," said ING rate strategist Alessandro Giansanti. "Investors are still hunting for yield and on top of that we see improving economic growth (in the periphery), reduced political risk in Italy, expectations of Portugal moving out of its bailout."
Data on Thursday showing private sector loans in the euro zone contracted further in February boosted ECB speculation even more.
Edging slightly lower from Wednesday, Spanish 10-year yields hit a new eight-year low of 3.25 percent. Italian yields hit a new 8-1/2 year low of 3.303 percent and Portuguese yields a new four-year low of 4.017 percent, according to Reuters data.
Despite the falls, the bonds still offered a premium over Bunds, which yielded 1.55 percent, 2 bps less than the Wednesday close. Greek bonds, the region's highest yielders, offered a 6.88 percent.
Evidence that the latest leg in the bond market rally was driven by ECB expectations could be found in the flattening of two/five-year yield curves and the steepening of the five/10-year yield curves, analysts said.
Five-year bonds outperform their peers when expectations of looser monetary policy grow as investors search for higher yields in longer-dated maturities and expect the tightening cycle to start later. While yields fall across the curve, 10-year yields fall less because of their term premium.
Five-year bond yields fell more than their two- and 10-year peers across the euro zone on Thursday. In Italy and Portugal five-year bond yields fell 4-8 bps.
Money markets also showed that investors were positioning for further policy easing. Forward overnight Eonia bank-to-bank borrowing rates, one of the best gauges of that, traded 3-6 bps below the 0.172 percent spot Eonia rate.
"They (the ECB) have not ruled out QE," one trader said, referring to quantitative easing, the term for central banks buying assets and printing money. "We've seen steady buying of bonds in Europe, especially the five-years."
(Editing by Catherine Evans and Nigel Stephenson)