Portuguese yields soar above 8 percent as political crisis swirls

Wed Jul 3, 2013 9:16am EDT

* Portuguese yields top 8 percent

* Cost of insuring Portuguese debt against default soars

* Italian, Spanish and Irish bonds also fall but by less

By Ana Nicolaci da Costa

LONDON, July 3 (Reuters) - Portuguese bond yields surged to more than 8 percent on Wednesday as a government crisis prompted investors to shun the bailed-out country, raising concerns about a renewed bout of euro zone debt trauma.

Stocks on the Lisbon bourse fell sharply and the cost of insuring Portuguese bonds against default rose to the highest level since November.

The resignation earlier this week of two ministers threatened to force an election over continued budget austerity, risking Portugal's goal of exiting its 78-billion-euro bailout by returning to regular bond markets next year.

Portugal's bond yields surged to levels near which it was forced to seek international aid two years ago. Prices suggested scant liquidity, or money flow, was exaggerating the moves, however.

Euro zone debt markets have been relatively calm since the European Central Bank announced last year that it would step onto markets under certain circumstances.

Portugal, however, may not meet the criteria as it is not fully back in the bond market yet.

"(The situation) will ... bring back discussion on whether the ECB has any interest in trying to prevent further increases in Portuguese yields," said Elwin de Groot, senior market economist at Rabobank said.

The sell-off extended to Italian and Spanish debt, but was less pronounced there. Investors favoured safety, securing demand at a German auction in line with this year's 1.9 bid-cover average.

Ten-year Portuguese yields surged at one point to 8.2 percent - their highest since November 2012 and were on track for their biggest daily rise since January 2012. They last stood 147 basis points higher at 7.99 percent.

Portugal would have to be growing at a 7-8 percent annual rate to be able to afford servicing its debt at these yield levels in the long run, de Groot said. The economy contracted 4 percent on an annual basis in the first quarter.

The difference between the yield implied by prices buyers offered and those sellers wanted to be paid for Portuguese 10-year bonds was last 292 basis points, double Tuesday's levels and the widest since August 2012. It suggested very low liquidity.

The gap in Italy, by contrast, was just 17 basis points.

Ten-year Spanish and Italian borrowing costs rose sharply but held below 5 percent. Ten-year Irish yields rose 8 basis points to 4.05 percent. Ireland is seen as on track to exit its bailout.

Greek 10-year yields surged 44 basis point to 11.62 percent, further inverting the yield curve and suggesting investors see an increased risk of default.

CONTAGION RISK

Analysts said the tamer reaction in Italian and Spanish debt, although significant, indicated support from domestic investors and continued faith in the European Central Bank's bond-buying programme.

Threadneedle Investments fund manager Martin Harvey said his firm's global funds had already reduced exposure to Italian and Spanish debt because of concerns over global central bank liquidity, but would stay put for now.

"We believe this is not a systemic issue at the moment, although we are watching it closely. I would be more concerned for Ireland over the next month or two if we were to see further stress in Portugal," he said.

He added that his firm was still positive on Irish bonds, however.

Higher borrowing costs for longer could, however, hurt Portugal's chances of exiting its bailout without further support and could make markets more prone to testing the ECB's resolve.

Against this backdrop, investors will scour ECB President Mario Draghi's news conference after a monetary policy meeting on Thursday for reassurances that the ECB has the region's back.

"Portugal looks very wobbly ... we think there is a highly increased (chance) of a second bailout being required," one trader said. "High-beta periphery is back in focus. Presumably this means the ECB is going to be dovish tomorrow."

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