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 LONDON: Portugal's bonds were steady on Thursday after it became the third euro zone country to seek financial aid but yields may well eventually push higher as the country grapples with a new phase of its debt crisis. Widely expected negotiations with Lisbon for financial assistance will take place as a campaign kicks off for a June 5 snap general election, leaving investors watching to see if a line will finally be drawn under the euro zone's debt woes or if speculators will turn on Spain.

"The absolute key for Portugal, Ireland and Greece is whether the continuation of liquidity provision can allow them to get the fiscal situation on a better footing, and if not they'll have to restructure (their debt)," said Gary Jenkins, head of fixed income at Evolution Securities.

"Bondholders need to look where Portugal is priced versus Ireland and Greece, look at what potential haircut they would be in for if such an event occurs and monitor the situation on an ongoing basis, looking at the economic data."

Yields on Portuguese government bonds fell by up to 35 bps on Wednesday, which traders said suggested there may have been some anticipation of the aid request ahead of an official statement late in the day.

But the relief may be short-lived if past events are an indicator - Greek and Irish yields resumed their rise shortly after bailouts were agreed.

"A bailout is somewhat in the price already, although you could argue it's come a bit sooner than expected," said a trader.

"Maybe it takes away a bit of uncertainty away but generally we see these knee-jerk positive reactions which then fade. It's all going to be a bit of a side-show to the ECB today anyway."

Commerzbank strategists said that Portugal could face further credit rating cuts, which would push the country to "junk" status and trigger more forced selling from accounts unable to hold lower-rated paper.

The European Central Bank meets later in the day and is widely expected to raise interest rates for the first time since mid-2008.

June Bund futures were 20 ticks lower at 120.42.

A sustained break below Wednesday's low of 120.51 would open the way to 120.00, analysts said, which corresponds to around 3.59 percent in 10-year yields.

Two-year bond yields were flat at 1.842 percent, with 10-year yields up 2 bps at 3.447 percent.

France will sell up to 9.5 billion euros of bonds and Spain will auction 3.5-.4.5 billion euros of three-year paper, which should see it completing around 35 percent of its year-to-date funding needs.

Spanish auctions have been well received this year, with an average bid/cover ratio of 2.0, according to Reuters data, rising to 2.3 for shorter-dated sales. "Spain has done quite well in the past number of months, separating itself from the stressed periphery, and indeed has managed to converge alongside Italy and Belgium in recent weeks," said ING rate strategist Padhraic Garvey.

"Contagion risk to other peripheral EMU members has significantly abated."

Spanish yields were flat in early trade.



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