ECB bets push Spanish, Italian, Portuguese yields to multi-year lows

* 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 multi-year lows on Thursday, with speculation about further European Central Bank monetary policy easing prompting investors to seek the bigger returns offered by 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 in this year's rally in peripheral bonds, which have outpaced 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 euro zone 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. "The more dovishly perceived ECB talk over the last couple of days has supported the push to lower yields across the EGB (euro zone government bond) space," said Norbert, European rates strategist at Nomura. While the euro has already stopped falling 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 that investors chasing higher returns would be forced to look down the ratings scale. The central bank meets next Thursday. Spanish 10-year yields fell 4 basis points to a new eight-year low of 3.25 percent while Italian yields were down by a similar amount to a new 8-1/2 year low of 3.289 percent. Portuguese yields slid to a new four-year low of 4.048 percent, according to Reuters data. Despite the falls, the bonds still offered a premium over Bunds, which yielded 1.54 percent, 3 bps less than the Wednesday close. Greek bonds, the region's highest yielders, offered 6.92 percent. "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," said ING rate strategist Alessandro Giansanti. Data on Thursday showing private sector loans in the euro zone contracted further in February boosted ECB speculation even more. ECB figures also showed euro zone banks mainly increased their holdings of sovereign debt in February after they passed the year-end deadline for balance sheet data under the central bank's asset review. Some in the market said banks seeking to offset the impact of rising loans on their budgets were also driving buying of peripheral euro zone bonds. Euro zone money supply http://link.reuters.com/zak35s Euro zone inflation http://link.reuters.com/vex45v ECB rates http://link.reuters.com/vex45v Peripheral bond yields http://link.reuters.com/vex45v

GAUGING EXPECTATIONS 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 basis points. 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. There was some scepticism though that ECB action was imminent despite the market expectations. "When ECB speakers talk about potential further measures the 'if needed' is the important bit in any comments about further easing which has to be seen against the backdrop of the ECB's easing bias," Aul said. "This is therefore basically a reiteration of the ECB's forward guidance and doesn't imply immediate action from the ECB."

(Editing by Hugh Lawson)