By Ana Nicolaci da Costa and Emelia Sithole-Matarise
LONDON, Aug 30 (Reuters) - Portugal’s bond yields jumped on Friday after its constitutional court rejected a labour bill that would have allowed public sector workers to be fired, in a blow to the austerity programme set out under Lisbon’s bailout.
The ruling raised concerns about Portugal’s ability to meet conditions to receive its next aid tranche and alarmed investors by suggesting the court could throw out more of the government’s planned savings measures.
Short-dated bond yields rose faster than longer-dated ones, in a sign that investors were pricing in higher credit risk. This flattened the yield curve and narrowed the spread between the two to its tightest since July, when the country suffered a government crisis.
“It raises the probability of the (next) tranche not being disbursed in time. It’s not the baseline scenario but it raises the probability and hence you have to discount it into your bond pricing,” Alessandro Tentori, global head of rates strategy at Citi said.
Ten-year yields rose 15 basis points on the day to 6.82 percent, but were still some way off levels above 8 percent hit in July.
Two-year yields rose 35 bps to 5.57 percent and five-year yields were 22 bps higher at 6.54 percent.
The yield spread between 10- and 2- year bonds narrowed to 125 basis points, its tightest in more than a month but was still way off levels in July when the spread went below zero.
Usually, long-dated bonds offer a comfortable pick-up over short-dated ones to compensate for the risk of holding an asset over a longer period of time.
Portugal’s prime minister said the government will overcome the obstacles it faces in its drive to reduce public spending under an EU/IMF bailout.
Some strategists, however, said the government might see renewed internal friction over its austerity measures, which could keep its yields elevated in coming months.
“We have to take into account that Portugal may need another bailout next year as it’s unlikely to come back full scale to the market as it planned,” said Alessandro Giansanti, a strategist at ING in Amsterdam.
Ten-year Spanish yields were little changed at 4.55 percent and the Italian equivalent was 2 bps higher at 4.40 percent with traders seeing very limited fallout for the bonds from the Portuguese ructions.
Elsewhere in the market, German Bund futures pared gains in choppy trading but were still poised for their biggest weekly rise since mid-July.
Bund futures settled 6 ticks higher at 140.66.
“We have got month-end, we have got a long weekend in the (United) States and, with Syria in the background, I can’t see why people would want to go home particularly short (Bunds) just in case something happens,” one trader said.
Jitters over Syria remained even though a decision that Britain will not join any military action against the country dealt a setback to U.S.-led efforts to punish Damascus over the use of chemical weapons against civilians.
Data out of the euro zone was mixed showing optimism improved sharply in August but that unemployment remains stubbornly high.