FRANKFURT (MNI) – Portugal’s financial situation is becoming more
untenable by the day and pushing it closer to an eventual bailout, but
the political limbo in Lisbon could yet result in a costly deferral of
EU/IMF aid and lead to further bond market interventions by the European
Central Bank.

On Tuesday, rating agency Standard & Poor’s cut the country’s
credit rating for the second time in one week to BBB- with a negative
outlook, driving Portuguese 10-year spreads up five basis points to 468
basis points, not far below the euro-era record high of +483 basis
points set last November. On Monday, S&P had slashed the credit ratings
of Portugal’s five largest banks.

The yield on the Portuguese 10-year bond is at 7.92% after today’s
downgrade, which is a new record high and compares with 7.23% eleven
days ago. The government has said that it considers rates above 7% to be
unsustainable.

Tensions in the bond market forced the ECB to intervene in the
government bond market last week for the first time since late February,
according to data published Monday. It seems likely that the continuing
turbulence this week could induce another round of bond buying by the
ECB.

The future is not looking bright: The Bank of Portugal warned
Tuesday that necessary new austerity measures yet to be adopted will
likely prolong the country’s recession through next year. “The adoption
of these measures implies a new, significant contraction of economic
activity similar to [the -1.4% that] is projected for 2011,” the bank
said.

Most observers expect Portugal eventually to be forced down the
path of Greece and Ireland, becoming the third Eurozone member state to
seek a bailout. Some even fret that Lisbon will be unable to finance
upcoming debt redemptions and coupon payments in mid-April and mid-June,
for a total amount of E12 billion.

Citing sources from the German finance ministry, German daily
Handelsblatt on Tuesday reported that the German government expects
Portugal will be able to secure the requisite financing in April with
short-term loans but will not be able to manage the July payments
without help.

ECB Governing Council member Nowotny said over the weekend that
given the situation, it was probably to be recommended that Portugal
seek aid from the European Financial Stability Facility (EFSF). However,
he warned that the current political morass in Lisbon could make that a
complicated proposition.

“Sustainable reforms [conditional for a bailout] can only be
carried out when there is a stable governmental constellation. That is
unfortunately not the case in Portugal,” Nowotny said.

Portuguese President Anibal Cavaco Silva may call early elections
for late May or the first week of June, it emerged Monday, raising hopes
that a “stable governmental constellation” could be in place in time to
apply for aid before the second batch of redemptions and coupon payments
fall due on June 15.

But even then, finalizing a package in time may prove difficult,
considering the parliament’s recent rejection of new austerity measures
that were backed by the European Commission and the ECB. Although Silva
assured that the three largest parties had expressed an “unequivocal
commitment” to meeting deficit targets, they have not presented concrete
alternative suggestions on how to get there.

A lot of works remains to be done, and European leaders, currently
caught up in arduous renegotiations over the bailout terms for Ireland
following the change of government there, will likely shrink from
negotiating with Portugal until a new government is firmly in place and
can’t back out of commitments.

In the meantime, the ECB will likely be obliged to continue
intervening in the sovereign debt markets to stabilize Portuguese bonds
and avoid any risk of contagion to other peripheral states.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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