March 25, 2011 / 1:34 AM / 8 years ago

UPDATE 2-S&P cuts Portugal credit rating, warns of further downgrade

* S&P says political uncertainty prompts credit downgrade

* Warns another cut likely next week depending on bailout fund

* Move comes a day after Fitch cuts Portugal by 2 notches

* Euro dips but quickly regains lost ground (Adds analyst comment)

By Ian Chua

SYDNEY, March 25 (Reuters) - Standard & Poor’s downgraded Portugal’s credit ratings by two notches to BBB on Friday and warned it could cut it again by one notch as early as next week depending on the final shape of the euro zone bailout fund.

S&P, which followed a two-notch cut by Fitch on Thursday, said the collapse of Portugal’s government has increased political uncertainty, hurting market confidence and potentially raising refinancing risk.

Whether there will be another downgrade hinges on the design of the bailout fund, or European Stability Mechanism (ESM), the S&P said.

“Based on current information and expectations, we could lower the ratings on Portugal again by one notch once the details of the ESM are officially announced,” S&P said in a statement. “Such a rating action could take place as early as next week.”

The agency said it would cut its rating again if the ESM raised the likelihood that Portuguese government bondholders become subject to a restructuring, or if the local market suffered a drop in trading liquidity.

The euro dipped to a session low around $1.4150 after the S&P announcement from $1.4171 late in New York on Thursday before recovering completely to $1.4179, indicating markets had already priced in the cut following Fitch’s move.

“The markets have expected that. The market is also expecting that at some stage Portugal will seek a bailout from the EU,” said Daniel Brdanovic, senior manager Treasury at HSBC in Auckland.

END GAME NEARING?

Senior euro zone officials said Portugal was likely to need 60-80 billion euros in assistance from the EU rescue fund and the International Monetary Fund. No talks have begun yet and will anyway have to wait until a new government is formed.

“Mixing political crisis with a lack of austerity package and a bond market that is unwilling, that is not a situation that can carry on for very long at all, so I think we’re moving towards that end game where Portugal is forced to seek help,” said Robert Rennie, strategist at Westpac Bank.

Despite Portugal’s rejection of austerity measures, S&P predicted the new government would eventually have to agree to the steps.

“We expect that a successor government would have no choice but to adopt some version of these reform proposals, given investors’ apparently reduced appetite for Portuguese government debt, though perhaps on a delayed basis,” S&P credit analyst Eileen Zhang said.

European leaders agreed on Thursday to increase their financial rescue fund to the full 440 billion euros by June, but avoided discussion of Portugal, which is under pressure to seek a bailout following the resignation of its prime minister.

Having said for weeks that they would agree a “comprehensive package” to tackle the euro zone debt crisis by the end of March, the leaders ended up delaying a final decision on boosting their safety net until mid-year.

The Portuguese upheaval underscored the wealth of political obstacles the single currency bloc faces in trying to solve a debt crisis that has deepened over the past year.

S&P said it could affirm the ratings at ‘BBB/A-2’ if “our current views about the ESM and its potential effect on Portugal’s sovereign debt were to change as a result of further developments and if we were to take the view that the downside and upside risks to our forecasts are broadly balanced.” (Additional reporting by Mantik Kusjanto; Editing by Balazs Koranyi)

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