LONDON (Reuters) - Portuguese government bonds outpaced their euro zone peers on Friday, with investors optimistic the three main political parties will reach a deal over the weekend to keep the country's bailout program on track.
Safe-haven German Bunds, meanwhile, briefly hit session lows after China's central bank announced long-awaited interest rate reforms in a move analysts expect will boost growth in the world's second-largest economy.
Portugal's Social Democrats and their two partners in the ruling coalition have given themselves until Sunday to conclude crisis talks requested by the president. The center-right ruling coalition defeated a motion of no confidence in parliament on Thursday, leaving investors optimistic.
"For now, I think the likelihood is that some form of compromise will be achieved at the weekend and hence, on really quite thin (volume), we are seeing another impressive performance in Portugal today," Richard McGuire, senior fixed income strategist at Rabobank said.
"At the moment, the yields at these levels have placed a question mark over Portugal's ability to return to the market but it has not closed the door to such an outcome."
Portuguese 10-year yields were 19 bps lower at 6.91 percent and five-year yields also 19 bps lower at 6.65 percent.
German Bund futures hit a session low of 143.99 after China's central bank said it would gradually relax controls on bank deposit rates. It was last 7 ticks lower at 144.16.
"We have seen bond markets weakening on these headlines as interest reforms are seen as a growth support for China," rate strategist Norbert Wuthe at Bayerische Landesbank.
"(It) isn't a substantial sell-off. As the Chinese central bank indicated this is a gradual process, so I wouldn't read too much into the immediate market reaction at this stage."
Elsewhere on the periphery, 10-year Spanish government bond yields were flat at 4.64 percent and the Italian equivalent down 1.7 bps at 4.41 percent.
Portugal's yield gap between 10- and five-year yields remained close to its lowest in a year, suggesting investors were still worried about the country's credit quality.
"The evident divisions as regards austerity between the two ruling coalition partners are likely to come back to the fore before too long," McGuire said, adding that the 2014 budget draft, which has to be presented to parliament by October 15, would likely highlight that rift.
(Editing by John Stonestreet)
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