By Emelia Sithole-Matarise

LONDON, May 21 (Reuters) - Portuguese bond yields touched a two-month high on Wednesday as a sell-off in lower-rated euro zone bonds deepened amid concern that European Union elections this week might derail economic reforms.

Weaker global equities also soured appetite for riskier assets, prompting some investors to book profits from a two-year peripheral euro zone bond rally that has driven weaker states' borrowing costs to historic lows.

The rally hit the brakes after a strong showing by Greece's anti-austerity Syriza party during local elections at the weekend, underscoring the potential that Eurosceptic parties might do well in EU polls starting on Thursday.

That could cause unstable coalitions to change course to regain popular support and reawaken fears about debts and budget deficits. Greece, where the ruling parties have the smallest majority, is seen as the biggest risk.

"We have seen since last Thursday some corrective action in these markets ahead of the EU elections. This can go further," said Matthias van der Jeugt, a strategist at KBC.

"We set absolute lows (in bond yields) during the rally that has been going since summer 2012 so some correction was eventually due."

Portuguese 10-year bond yields PT10YT=RR rose as much as 12 basis points to 4.14 percent, the highest since March, according to Reuters data. They have risen almost 70 bps in the past week from an 8-1/2-year low of 3.43 percent hit a week ago.

Italian equivalents rose to their highest in nearly two months before retreating slightly IT10YT=RR with investor focus also on a debt swap in Rome aimed at smoothing the country's debt repayments. Spanish yields ES10YT=RR rose to levels last seen early last month of 3.17 percent.

OVERSTRETCHED

Traders say investors were also overloaded with peripheral debt after buying 5 billion euros of Spanish inflation-linked bonds and 14.25 billion of Italian debt last week and were scaling back positions before more bond sales this week.

Spain plans to sell up to 3.5 billion euros of bonds on Thursday. Italy is offering up to 2.5 billion of five-year bonds in exchange for some 2015 and 2017 bonds.

Many in the market expect a resumption of the peripheral bond rally once the EU elections are out of the way, given expectations that the European Central Bank will inject more monetary stimulus next month.

"We have not changed our view in that our target for 10y BTP/Bund spread is still 100 basis points, however it seems investors will seemingly need to be patient for a market reversal," RBS strategists said in a note.

Italy's 10-year bond yield premium over German Bunds was around 192 bps on Wednesday, its highest in nearly three months.

(Editing by Susan Fenton)

((emelia.sithole@thomsonreuters.com)(+44 207 542 6752)(Reuters Messaging: emelia.sithole.thomsonreuters.com@reuters.net)) 

 ((--------------MARKET SNAPSHOT AT 814 GMT ------------------ Futures continuous contract basis Current levels versus prior European close                         FUTURES           CASH YIELD THREE MONTH EURO        99.740 (-0.005)  0.031 (-0.004) TWO-YEAR SCHATZ        110.620 (+0.015)  0.078 (-0.007) 10-YEAR BUND           146.170 (+0.080)  1.352 (-0.003) 30-YEAR BUND                             2.273 (+0.004) 2/10 YIELD CURVE SPREAD     1.274 (+0.004) 10/30 YIELD CURVE SPREAD    0.921 (+0.007) 2-YR SWAP RATE (BID)        0.380 (-0.001) 10-YR SWAP RATE (BID)       1.590 (+0.002) 30-YR SWAP RATE (BID)       2.291 (+0.011) 2/10 SWAP CURVE SPREAD      1.210 (+0.003) 10/30 SWAP CURVE SPREAD     0.701 (+0.008) 2- YR BUND/SWAP SPREAD      0.302 (+0.006) 10-YR BUND/SWAP SPREAD      0.238 (+0.005) BREAKEVEN RATE (OATei 07/20)    2.119 (-0.001) 10-YR BUND/UST SPREAD       1.160 (+0.006) 10-YR BUND/OAT SPREAD       0.505 (+0.016) 10YR BUND/BONO SPREAD       1.759 (+0.028) 10-YR BUND/BTP SPREAD       1.917 (+0.012) 10-YR BUND/GGB SPREAD       4.486 (+0.020) 10-YR ITALIAN BTP FUTURE       122.260 (-0.190)                       EURO      STERLING  DOLLAR OVERNIGHT LIBOR       0.14429   0.46500   0.08790 ONE-WEEK LIBOR        0.19714   0.46156   0.11635 ONE-MONTH LIBOR       0.23143   0.48719   0.14775 THREE-MONTH LIBOR     0.29286   0.52775   0.22810 3/MTH LIBOR/OIS SPREAD    17.38600 (+0.004)  11.39500 (+0.000)  14.81000 (+0.004) Current levels versus prior European close For relative performance tables see below ------------------------------------------------------------))

Keywords: MARKETS BONDS/EURO