Portuguese bond yields rise on concern BES will need a state bailout

Fri Aug 1, 2014 6:49am EDT

* Portuguese bonds underperform other euro zone debt

* Expectations of ratings upgrade cap rise in Greek yields

* Price moves in rest of market modest before U.S. jobs data (Recasts with rise in Portuguese yields, adds new analyst comment)

By Emelia Sithole-Matarise

LONDON, Aug 1 (Reuters) - Portuguese bond yields rose on Friday, maintaining their underperformance compared with the rest of the euro zone, amid expectations Lisbon will bail out the country's biggest bank after it reported massive losses.

Banco Espirito Santo's problems intensified this week. The bank posted a worse-than-forecast 3.6 billion-euro loss and saw its top officials suspended over suspected harmful management. Its shares fell to record lows.

This put renewed pressure on Portuguese bonds. Analysts said the Bank of Portugal would prefer BES raise capital from private sources, but shaken investors may not stump up the full amount, leaving the government to fill the gap.

Portugal, which just emerged from a sovereign bailout in May, has 6.4 billion euros of funds for any bank recapitalisation and the treasury has already raised cash to cover financing needs into next year.

The events at BES ahve unsettled some investors. Portuguese 10-year bond yields rose as much as 12 basis points to 3.87 percent, adding to Thursday's 10 bps jump.

"The Banco Espirito Santo problems don't seem to be going away that easily," said Alessandro Giansanti, a strategist at ING. "Portugal have said they want capital for BES from private investors, but I don't think it will be enough. They will need to use the money set aside for banks and that should be enough to cover any further recapitalisation of the bank."

A more cautious tone among investors towards riskier assets before a U.S. jobs report later on Friday and holiday-thinned volumes exacerbated the moves in Portuguese bonds.

ANTICIPATING MOODY'S

Greek 10-year bond yields, which usually see larger swings because of their low liquidity, were up 3 bps at 6.09 percent. They fell earlier as investors anticipated a credit ratings upgrade from Moody's later in the day.

Moody's has an extremely speculative Caa3 rating on Greece, the worst in the euro zone. It is scheduled to review the rating on Friday, although any announcement will come after the market closes.

Some market participants say an upgrade looks possible. Greece's economic outlook has improved and its held two successful debt sales this year, after its 2012 default.

Moody's one-notch upgrade of Portugal's ratings despite the problems facing its biggest bank fuelled expectations of similar action for Greece.

"Moody's is still lagging the other rating agencies, so a bit of a catchup upgrade for Greece by about up to two notches is very possible," said Rainer Guntermann, a strategist at Commerzbank. "It won't come as a big shock to the market, but as always with official confirmation some accounts may feel more comfortable in adding to their positions (on Greek bonds)."

Italian 10-year yields were up 7 bps at 2.77 and the Spanish equivalents up 6 bps at 2.57 percent before the U.S. jobs report, which may shed light on when the Federal Reserve will end its ultra-easy, risk-friendly monetary policy.

Due at 1230 GMT, the non-farm payrolls report was forecast to show 233,000 jobs were added last month and the unemployment rate held steady at 6.1 percent.

Some traders said the market was already positioned for a strong figure and would need to see a big number - 250,000 and above - for a durable upward move in U.S. Treasury yields.

The effect of potentially higher U.S. yields on euro zone bonds should also be tempered by Thursday's report on inflation in the region, which fell to its lowest in almost five years in July.

"If expectations for the Fed's gradual normalisation in policy do indeed pan out, then there is, we feel, a strong argument to suggest that not only will core euro yields remain well bid, but that the higher-yielding peripheral market will see even greater demand," Rabobank strategists said in a note.

"Yield hunters (will) look to a corner of the rates world that is, for the time being, going to remain very much supported by an ECB that is very much on a mission." (Editing by Larry King)

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