UPDATE 1-Market pins hopes on softer Brexit; Portuguese rating in focus

* Risk appetite grows as threat of no-deal Brexit appears to fade Portuguese/Spanish spread tightest ever before ratings review

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates pricing, adds inflation data)

By Virginia Furness

LONDON, March 15 (Reuters) – Core euro zone bond yields edged higher on Friday, after British lawmakers voted to delay a potentially chaotic exit from the European Union, while attention turned to a ratings decision for Portugal.

Markets are now trading on expectations of a “softer” Brexit and the receding likelihood of no deal, analysts said.

“We have seen a risk-on trade for Brexit in the last couple of days as the market thinks it is less likely we will leave without a deal,” said Lyn Graham-Taylor, rates strategist at Rabobank.

German 10-year government bonds struggled to find direction in early trade as the market digested overnight developments. Yields nudged down around 1 basis point to 0.076 percent , then rose a basis point to 0.095 percent. Other core euro zone bond yields were also about a basis point lower.

Euro zone inflation rose as expected in February, the EU’s statistics office said on Friday, mainly because of more expensive services, food, alcohol and tobacco.

Ratings agency action was in focus with Moody’s and Standard & Poor’s set to review their credit ratings of Italy and Portugal.

“No news will be good news for Italy, but not for Portugal,” Commerzbank analysts wrote in a note.

Portuguese yields held near historic lows before the S&P review on Friday. Portugal could upgraded from BBB- with a positive outlook rating from S&P.

Once a pariah of euro zone debt, 10-year Portuguese government bonds are now trading only 10 basis points wider than those of higher-rated Spain, the tightest spread for at least 25 years. Portugal is Baa3/BBB-/BBBv with Spain at Baa1/A-/A-.

In fact, five-year Portuguese bond yields are now trading close to their Spanish counterparts.

Moody’s will update its Baa3 rating for Italy after lowering its forecast last month for the country’s gross domestic product to growth of 0.5 percent or lower. Commerzbank analysts say that a negative outlook for Italy is “distinct risk”.

The spread of Italian 10-year debt over top-rated Germany was 240 basis points, having touched highs of close to 300 basis points on Feb. 8.

Elsewhere, the Bank of Japan maintained its current easing framework and guidance but downgraded its economic outlook on Friday, joining the ranks of dovish central banks.

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