GLOBAL MARKETS-World stocks, oil advance; Portugal yields surge

* World stocks set for third straight quarterly rise

* Crude up 22 pct this qtr -- best performing major asset

* Yen hits 10-month low vs euro

By Dominic Lau

LONDON, March 31 (Reuters) - World stocks hit a three-week high on Thursday and the euro firmed, but Portuguese government bond yields hit fresh euro lifetime highs as the country missed a budget target and its credit rating was downgraded again.

World stocks have now recovered all of the losses from a sharp sell-off after disaster struck Japan earlier this month and are heading for their third quarterly gain in a row thanks largely to improving U.S. growth.

But the euro zone debt crisis intensified with news of Portugal's troubles and ahead of the publication of Irish bank stress tests.[ID:nLDE72U17E][ID:nWLA6919]

Portugal's budget deficit reached 8.6 percent of gross domestic product in 2010, above a target of 7.3 percent agreed with Brussels, statistics agency INE said on Thursday.

The yield premium that investors demand to hold Portuguese rather than benchmark German bonds rose to 508 basis points, 12 bps wider on the day, as the country's 10-year yields hit a fresh euro lifetime high of 8.476 percent.

Portugal's stocks <.PSI20> lost 0.9 percent.

Despite the debt crisis, the European Central Bank has continued to signal that it could raise its benchmark interest rate next week to curb inflation, a message that has kept the euro strong against other currencies.

The yen fell to a fresh 10-month low versus the euro and touched a three-week trough against the dollar as expectations grew that Japan would lag the euro zone and U.S. central banks in raising interest rates. So far this year, the euro has risen nearly 8 percent against the yen.

"Rate differentials are playing a big role, especially as there is no probability for the BOJ to become more hawkish, even in the medium to long-term." said Manuel Oliveri, currency strategist at UBS in Zurich.

The euro was up 0.6 percent at 117.77 yen and the dollar was steady at 82.83 yen after reaching 83.21 yen earlier.

The European common currency was up 0.6 percent at $1.4219 , boosted by quarter-end and fiscal year-end flows, traders said.

Europe's FTSEurofirst 300 <.FTEU3> share index fell 0.5 percent, while Irish shares <.ISEQ> rose 0.5 percent and yields on Ireland's 10-year government bond remained elevated above 10 percent.

The Irish Independent said Dublin's stress tests would show an additional 20-25 billion euro hole in its banks capital -- broadly in line with expectations -- and will be followed by a radical restructuring of the sector. [ID:nLDE72U0DD]

A source familiar with the process said Ireland would merge EBS building society into Allied Irish Bank as part the overhaul [ID:nDUB003347]. Trading in Allied Irish Bank and Bank of Ireland was suspended.

U.S. stock index futures were flat to up 0.1 percent, indicating a steady start on Wall Street.

OIL TENSIONS

Brent crude rose 1 percent above $116 a barrel and were up 22.7 percent for January-March, on track to become the best performing major asset in the first quarter of 2011 as political unrest in the oil-rich Middle East and North Africa ignited supply concerns.

Copper , however, was down 2.5 percent this quarter.

Higher oil prices, seen as a tax on global growth, have not yet knocked world equities off their stride. Global equities measured by MSCI All-Country World Index <.MIWD00000PUS> advanced 0.3 percent, on track for a 4.1 percent gain for January-March -- the third straight quarterly rise.

MSCI emerging markets index <.MSCIEF> rose for the third day, up 0.7 percent and were on track to gain 1.4 percent for the first quarter, recovering losses from earlier this year when investors shifted their money to developed market equities on concerns over inflation in developing countries.

However, emerging market shares still underperformed developed market equities, whose strong performance was mainly driven by gains in U.S. stocks. The Dow Jones industrial average <.DJI> is up 6.7 percent this quarter.

"While we remain comfortable with being overweight financials, we see less need in making such hard distinctions now given the improving background in China and the reduced scope for economic surprise in the U.S. in the short term," Deutsche Bank said in a note.

"Increasingly we find ourselves looking for opportunities across the cyclical stocks as whole, both global and domestic." <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Asset returns in Q1 2011 graphic: http://r.reuters.com/wur78r Key events in Q1 2011 timeline: http://r.reuters.com/saj68r ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

Japan's Nikkei average <.N225> added 0.5 percent.

Japanese fund managers cut their global stock weighting to a 12-year low in March, while raising their bond weighting to an all-time high as they reduced risk positions after the earthquake, a Reuters survey showed. [ID:nL3E7EV15T] (Additional reporting by Neal Armstrong; Editing by Ruth Pitchford)