UPDATE 4-Portuguese prime minister tries to defuse crisis

Wed Jul 3, 2013 3:44pm EDT

* Government's majority hinges on CDS-PP party support

* CDS-PP leader Portas to meet Prime Minister Passos Coelho

* PM to try compromise, early election increasingly likely

* Portugal has funds to meet 2013 needs if bailout suspended

By Axel Bugge and Daniel Alvarenga

LISBON, July 3 (Reuters) - Portugal's prime minister and his junior coalition partner in the government attempted on Wednesday to cool tempers in a political crisis that could derail Lisbon's efforts to emerge from its international bailout.

Prime Minister Pedro Passos Coelho said his government would survive the crisis created by the resignations of Foreign Minister Paulo Portas and his finance minister this week, which have threatened to deprive it of a majority in parliament

"I am confident that we will be able to overcome this difficulty," Passos Coelho told journalists after a meeting of European leaders to discuss youth unemployment in Berlin.

Portas's rightist CDS-PP party met all day on Wednesday and decided their leader would talk to the prime minister in an attempt to find a way out of their dispute, the worst political rift since Portugal received a bailout in 2011.

Luis Queiro, a senior member of the CDS-PP, said the talks would aim to "define the circumstances that guarantee a viable solution to the governing of Portugal".

Despite the moves to heal the rift, which was sparked by deep and growing misgivings in Portugal over the government's relentless austerity drive to meet the terms of its bailout, many analysts said it was only a question of time before the government fell.

President Anibal Cavaco Silva's office said he had begun meetings with political parties to seek a solution, which would go on through the week.

OPPOSITION WANTS ELECTION

Antonio Jose Seguro, leader of the main opposition Socialists, made clear after meeting the president that his party wanted an early election.

"We consider that the country has to return rapidly to having a government with cohesion and strength," Seguro told journalists, proposing a vote on Sept. 29, to coincide with local elections.

With no solution imminent, Portugal's bond and stock prices tumbled. Lisbon's creditors - the European Union and International Monetary Fund - are due in Lisbon to start their next review of the economy on July 15, but that visit might now be delayed.

Passos Coelho said he thought agreement could be found with his coalition partner.

"So far, despite all the problems, the two parties in the coalition have managed to put national interests above their local differences and have shown the country the majority is working. It's certainly not now that we'll put that at risk."

Passos Coelho has fought to keep Portugal on course to complete its 78 billion euro ($102 billion) bailout next year as scheduled, but the measures have pushed it deeper into its worst economic crisis since the 1970s.

The returns investors demand to hold 10-year bonds surged to above 7.9 percent on Wednesday for the first time since November and the PSI 20 stock index closed 5.3 percent lower, led by losses of over 10 percent in bank shares.

SUPPORT FADING

Finance Minister Vitor Gaspar, architect of the spending cuts and tax hikes required by Portugal's lenders, stepped down on Monday, citing an erosion in support for the bailout.

Portas resigned the next day because he objected to the appointment of Treasury Secretary Maria Luis Albuquerque to replace Gaspar.

Passos Coelho refused to accept Portas's resignation, forcing Portas to choose between staying on and pulling his party out of the coalition, robbing it of its majority.

European Commission President Jose Manuel Barroso, a former Portuguese premier, said Portugal risked damaging its hard-earned financial credibility after two years of closely following its bailout programme.

"This delicate situation requires a great sense of responsibility from all political forces and leaders," he said.

The president has the power to dissolve parliament and call an election, but he has indicated that if political parties want to unseat the government they must win a vote of no confidence.

"One thing is certain, the prime minister is going to do everything to stay on, giving all possible concessions to Portas," said political scientist Antonio Costa Pinto. "Failing that, however, we can hardly avoid an early election."

Portugal had been hoping to exit its bailout and return to normal debt market funding next year, but the strength of opposition to continued austerity has now thrown this into doubt.

Bank of America Merrill Lynch analysts said the combination of surging yields and political uncertainty "reduces the prospects of Portugal regaining full market access in the next year", raising the prospect of a new bailout being required.

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