March 4, 2016 / 10:50 AM / 2 years ago

Portugal's bond yields rise as rating tests begin

* Fitch expected to remove positive outlook on Portugal

* Move could hint at crucial DBRS review next month

* DBRS holds key to Portugal’s QE qualification (Updates prices)

By John Geddie

LONDON, March 4 (Reuters) - Portuguese government borrowing costs rose sharply on Friday as the first of several back-to-back tests for its credit rating approached.

German Bund yields inched up 2 basis points to 0.20 percent after above forecast U.S. jobs data.

Lisbon’s bonds have recovered after a sell-off in mid-February, boosted partly by data showing global growth worries may be exaggerated and relief that the new Socialist government tightened its budget plan last month after pressure from the European Commission.

Rating agencies and others, however, have raised concern over whether more cost-cutting will be needed to reduce Portugal’s deficit.

Fitch will be the first of three agencies to assess Portugal’s rating over the coming two months, building up to a ruling from DBRS that could downgrade Lisbon to below investment grade. That would make its bonds ineligible for the Euroopean Central Bank’s asset-purchase programme.

“While (Fitch‘s) rating action would not be overly significant in itself, we see the risk that investors will make inferences ... for the crucial review from DBRS,” Commerzbank strategist David Schnautz said. “Overall, we hold on to our cautious stance in PGBs (Portuguese government bonds).”

Fitch rates Portugal at BB+, one notch below investment grade, with a positive outlook. But it warned in January that the country’s anti-austerity budget may be unrealistic and could lead to weaker growth and a rating cut.

Analysts expect Fitch to remove its positive outlook in a decision due after markets close on Friday. It may switch to a negative outlook, which would not bode well for a review from Standard and Poor’s due on March 18.

More importantly, DBRS releases its review on April 29. It is the only one of four agencies recognised by the ECB that has an investment-grade rating for Portugal. Without that rating, Portugal would not qualify for the ECB’s bond purchases.

Last month DBRS said it was comfortable with its BBB (low) ‘stable’ rating for Portugal but raised concern about a rout in its bonds that sent yields close to a two-year high of 4.38 percent on Feb. 11.

DBRS said the rise in yields could become a problem, given Lisbon’s high refinancing burden. Around a third of Portugal’s 148 billion euros of outstanding debt falls due over the next three years.

Portugal’s 10-year yields rose 5 basis points to 2.93 percent on Friday, up from near one-month lows of 2.85 percent hit at the end of last week.

All other euro zone equivalents were up 1-3 basis points.

The fourth agency whose rating is recognised by the ECB, Moody‘s, skipped a review of Portugal’s junk Ba1 rating on Jan. 15. It said this week that Lisbon still needs significant fiscal consolidation to reduce its debts and its banking system is not strong enough to support economic recovery. (Reporting by John Geddie; Editing by Gareth Jones)

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