WE WERE on our way back down from Lisbon cathedral to the Tagus. The steep little street was lined with bars and grocers' shops. At the bottom, where it joined a busier street, a thin small man in his fifties, in a shabby dark suit and a flat cap, was leaning against the wall, before the street corner, with his arm oddly outstretched.

As we got nearer, we saw why. He was holding a fine wire. It led to a 2,000-escudo (pounds 10) note lying on the pavement of the cross-street. If he twitched the wire, unseen, he could make the note flutter. We looked around. At every shop or bar doorway, two or three people were watching expectantly. We waited as well. Two plump, prosperous women came along, hesitated, then one of them bent down. The note whisked away. From every doorway came a happy shout of laughter. The women smiled sheepishly. The thin man jerked his lure back into place. There was all the time in the world. It was his Saturday morning trick.

In Portugal, you often feel you are in a sunnier version of Ireland, or in the England your grandparents told you about. Lisbon has much of the charm of Dublin. Architecturally, it is not a city of European greats: no St Mark's Square, no St Paul's, no Notre Dame. Its delight lies in the way it hugs the hills beside the lagoon-like Tagus estuary, and the way so much of its life seems held over from an earlier day. Yet most visitors to Portugal still go straight to the beaches or golf courses of the Algarve. The capital and its surroundings are much less explored.

We had come up to see the fortress-like cathedral on one of Lisbon's bright-yellow trams. These are British-built, from before the First World War. The interiors are lined with wood. It is like travelling inside a cigar box. By the cathedral the trams go up the steepest slope traversed by trams anywhere in the world without rack and pinion. The street becomes so narrow that the track comes down to a single line, and each tram has to wait to make sure the way is clear.

Near the end of the line, beyond the cathedral, stands the bright white, pompous mausoleum where the terminal dynasty of Portuguese kings are buried. The dynasty hit the buffers in 1910, with Manuel II ('The Unfortunate'), whose father and elder brother were assassinated in Lisbon's main square, next to the General Post Office, only two years before he was deposed by an army conspiracy with strong Masonic undertones.

The Portuguese are infinitely courteous. They seem slow to anger, and slow to smile. They are the only Latin people who talk without moving their hands. But things are less calm below the surface. When another army conspiracy overthrew the heirs of the dictatorial Salazar 20 years ago, the undertones were Communist. Lisbon was a hair's-breadth from undergoing the last Communist coup in Europe. Even now, the hammer and sickle adorn the walls of the poorest streets.

Behind the royal mausoleum lies Lisbon's flea market. An old woman is selling a large enamel coffee pot and two packets of old postcards, held together with elastic bands. That is it. We hadn't meant to go to the mausoleum or the flea market, but the man on the seat in front of us on the tram had been a waiter in New York. He wore a plastic hat and the biggest, most gilt-laden wristwatch I had ever seen. 'Don't get off there,' he said as we reached the Romanesque cathedral. 'Nothing to see. Come up and see the tombs.' It seemed rude to refuse.

We came back down to the cathedral through the city's oldest neighbourhood, the Alfama. This is one of the few districts spared by the earthquake of 1755, in which, one Sunday morning thousands of people were killed. The Alfama spills down the hill towards the Tagus. On the hilltop stand the ruins of a castle, where everyone goes to promenade and see the caged peacocks. The narrow alleys and steps of the Alfama are like a cross between Brixham and Naples. The close-set houses are white-painted and picturesque. The main street is full of shops and stalls selling unfamiliar fish.

Before settling into the city, see its context. Hire a car and drive north to Coimbra, Portugal's oldest university town. You can whizz up there along the brand-new motorway, then drift back along by-roads; or vice-versa. (Hand in your car again at Lisbon and buy a tram and bus pass.) At the roadside, orange trees were still laden with fruit, well past picking time. They are not a tourism gesture. Portugal's political class desperately wanted to join the EC, as a democratic endorsement. But without tariff protection, the small farmers of Portugal have been destroyed by Spain's agribusiness.

Coimbra's cathedral is almost a twin of Lisbon's. It was also built by medieval Frenchmen. It was from Coimbra that Professor Salazar was plucked, in the Twenties, to rescue the bankrupt republic. On the brow of the hill, as a proud alumnus, Salazar put massive new faculty blocks in best fascist style: a stripped-down classicism, with huge symbolic statuary. Looking along the wide avenues, you feel caught up in a De Chirico painting. It is perversely impressive.

But the old university, through a baroque doorway, is one of the closest things in continental Europe to an Oxford or Cambridge college. An open-ended quadrangle looks out, high above the river valley. The chapel and the library are the jewels. They drip with gold leaf, and the surface decoration that is the signature of Portuguese art runs riot.

Portugal is a lace-making country, and a laciness marks its most characteristic architecture. At the monastery-church of Batalha, south of Coimbra, the cloisters are patterned as fancily as doilies or antimacassars. In a chapel here lies John of Gaunt's daughter, Philippa, who married a Portuguese king.

Stay the night, perhaps, at Obidos, a delectable walled town stranded by history that manages not to seem museumised. The church interior is kept cool by its lining of old blue tiles, in luxuriant plant designs. Then go to Nazare and eat sweet sole within sight of the sea.

Back in Lisbon, much of the pleasure comes from sauntering around. Take at least three days over it. (The restaurant-lined Bairro Alto, or 'Upper Quarter', is the best place to eat.) But make sure you go out to the Tower of Belem, near the Hieronymite monastery. It was built as a fortress, in the early 16th century, just after Vasco da Gama reached India. In style it is half Moorish. Standing on the battlements, with the docks of Lisbon and the high Tagus bridge behind you, you feel something of the expansionist excitement of those merchant venturer years.

Artworks are a sort of treasure hunt: a fine baroque chapel at Sao Roque church; a Hieronymus Bosch (his greatest triptych outside the Prado, and as bizarre as ever) at the National Museum of Ancient Art. Lisbon's best-known gallery is the Gulbenkian Museum. The Islamic and Oriental art is astonishing. The core of the museum is 18th-century French. There is a fine Dutch Annunciation (by Dieric Bouts) and some delightful Corot and Boudin landscapes.

For a final immersion in Portugal, seek out the Tile Museum in some skilfully converted church cloisters, tucked away behind railway tracks to the east of the centre. The church itself, which you peer into through glass, is Lisbon's best baroque, an amazing creation. But the tiles are an unparalleled delight, summing up all those you've seen on your journey. Don't leave without having the museum restaurant special - a casserole of meat and clams - as you look out into a cool, almost Arabic courtyard. This is the nicest setting in Lisbon, and a good place to contemplate coming back.

Flights: Scheduled services from London to Lisbon are operated by British Airways (081-897 4000) and TAP Air Portugal (071-828 0262): official return fares start at pounds 184 mid-week (pounds 199 weekend) for a stay including a Saturday night. Portuguese specialist Abreu Travel (071-229 9905) offers return fares with TAP from pounds 100.

Packages: Short-break specialists that feature Lisbon in their programmes include Time Off (071-235 8070), which offers two-night packages to the one-star Hotel Borges from pounds 225, including return air travel and B&B accommodation. A two-night package with BA Holidays (0293 615353) costs from pounds 211.

Books: Recommended guides include the new Insight Pocket Guide to Lisbon (APA Publications, pounds 3.99) and the new Berlitz Pocket Guide to Lisbon (Berlitz, pounds 4.95) with a useful map of the city.

Car hire: Seven days' hire with Hertz (081-679 1799) with its Europe on Wheels programme costs pounds 149 unlimited mileage, collision damage waiver and local tax.

Further information: Portuguese National Tourist Office, 22/25a Sackville Street, London W1X 1DE (071-494 1441).

(Photographs and map omitted)