March 31, 2011 / 1:10 PM / in 7 years

Euro zone hit by Portuguese deficit, Irish banks

<p>People walk past a bank in Dublin March 31, 2011. Ireland will publish what is meant to be the final bill for propping up its banks on Thursday in a last-ditch bid to convince investors it can avoid deepening Europe's debt woes with a damaging restructuring. REUTERS/Cathal McNaughton</p>

LISBON/DUBLIN (Reuters) - Portugal revealed on Thursday that its budget deficit had ballooned above target and Ireland said its banks needed 24 billion euros in extra capital, shaking euro zone markets and deepening the bloc’s debt crisis.

European leaders had hoped a package of anti-crisis measures agreed at a Brussels summit last week would help draw a line under the woes that have plagued the 17-nation currency area for over a year, forcing bailouts of Greece and Ireland.

But volatile developments on Thursday showed why the bloc is likely to remain under pressure for some time, even if many investors have turned their attention in recent weeks to the conflict in Libya and nuclear disaster in Japan.

In an echo of the Greek deficit revision in late 2009 that first stoked market concerns about euro zone finances, Portugal presented new figures showing its 2010 budget deficit totaled 8.6 percent of gross domestic product (GDP), more than a full point above the 7.3 percent the government had been targeting.

Lisbon said the upward revision was due to a simple accounting change demanded by Europe’s statistics agency rather than any attempt to deceive, but bond markets responded by pushing the yields on Portuguese bonds to new euro-era highs.

“These (revisions) are very much one-off factors and don’t have a bearing on the deficit for next year,” said James Nixon, European economist at Societe Generale. “That doesn’t mean to say there shouldn’t be a funeral march for Portugal. Funding is untenable given where yields are.”

Portugal had been under intense pressure to seek financial assistance from the EU and IMF even before Prime Minister Jose Socrates stepped down last week following the rejection of his latest budget cuts by parliament.

On Thursday, President Anibal Cavaco Silva dissolved parliament and set a June 5 date for a snap general election, meaning two more months of political uncertainty when the country can least afford it.

LINE IN THE SAND

While Portugal’s main problem is its lack of competitiveness and sluggish economy, Ireland’s woes are largely down to its banks, whose reckless lending during the “Celtic Tiger” boom years ended up tearing huge holes in their balance sheets when the global financial crisis hit.

Ireland had hoped to persuade investors that it had its stricken financial sector under control by presenting the results of new “stress tests” for its banks on Thursday.

It said its four remaining lenders -- Allied Irish Banks (ALBK.I), Bank of Ireland BKIR.I, EBS building society and Irish Life and Permanent -- needed another 24 billion euros to withstand potential losses from a weaker economy.

The loss figure was in line with expectations and fell within the 35 billion euros set aside for the banks in Ireland’s EU/IMF bailout last year.

The tests were praised as “rigorous” by the European Commission, IMF and European Central Bank, which issued a joint statement calling them a major step toward returning the banking system to health.

But some economists fear more losses may be lurking at the four banks, which are to be restructured into two lenders under plans announced on Thursday.

“This is the fifth recapitalization of the banks and it’s highly unlikely that this will draw a line in the sand,” said Stephen Kinsella, an economics professor at the University of Limerick.

Compounding the problem was news that vital support from the ECB may not be forthcoming.

Euro zone official sources told Reuters on Thursday that due to internal disagreements within the ECB’s Governing Council, plans to announce a new liquidity facility for Irish banks had been scrapped.

The ECB is struggling to find a solution to how it reins in the emergency support it has given to money markets since the financial crisis hit in 2008, without paralyzing some banks.

Patrick Honohan, the governor of Ireland’s central bank, played down the importance of the ECB liquidity deal, saying he was “reasonably relaxed”.

FUNDING CRUNCH

Portugal’s president said Socrates’ government would remain in office in a caretaker capacity until the election. It has strongly resisted pressure to seek a bailout and would have diminished power to secure one even if it wanted to.

The leader of Portugal’s opposition has pointed to the option of a bridging loan to tide the country over until a new government is in place.

News of the higher-than-expected deficit -- due to losses at a nationalized bank and public transport companies -- came ahead of a funding crunch in which the government must refinance a total of roughly nine billion euros in debt in April and June.

“The government is not irresponsible and will guarantee that there is the necessary financing so the country can live up to its responsibilities and honor commitments to its creditors,” Finance Minister Fernando Teixeira dos Santos insisted.

But the state bond agency, in its plans for the second quarter, admitted that any bond issuance would be subject to market conditions -- a reference it has not made previously that suggests doubt about finding buyers at feasible prices.

Portuguese 10-year yields climbed above 8.6 percent, more than five percentage points above German bonds.

The latest turbulence has not hurt the euro, which was trading at $1.4170 on Thursday and has risen steadily against the dollar since the start of the year, driven by expectations the ECB will begin tightening monetary policy next week. (Writing by Noah Barkin, Patrick Graham and Sophie Walker; editing by David Stamp)

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