Portuguese bond rate at danger level amid political crisis

The political crisis in Portugal immediately hit the country's 10-year borrowing rate on Wednesday, pushing it up sharply to the danger level of 8.0 percent.

The rate, or yield, on existing Portuguese 10-year bonds traded on the open market shot up from 6.720 percent late on Tuesday to 8.023 percent in initial trading, then eased to slightly below 8.0 percent.

The surge came in response to the resignation late on Tuesday of Foreign Minister Paulo Portas, who heads a small party in the centre-right coalition.

Prime Minister Pedro Passos Coelho has refused to accept the resignation in an attempt to hold the coalition together, after his Finance Minister Vitor Gaspar, the architect of drastic austerity policies, resigned on Monday.

The borrowing rate is of critical importance to Portugal which is fighting with deep austerity measures to regain credibility in order to emerge from a bailout programme and return to borrow normally on capital markets next year.

The borrowing rate indicated by 10-year bonds had fallen to 5.2 percent in May. In January 2012 it had risen to a high point of 18.0 percent.

At BNP Paribas bank, bond strategist Patrick Jacq commented: "If there are more resignations, the coalition might break up and that could lead to an early general election."

Investors are worried that the crisis could undermine the programme of reforms imposed by the International Monetary Fund and European Union in exchange for bailout funding.

Jacq, referring also to a sharp fall of stock prices on leading European markets and in Portugal, said: "The risk is limited but the risk exists and this explains the reaction of the markets."

Jacq noted that until now the EU, IMF and European Central Bank had approved the actions by Portugal to correct public finances and strengthen the economy.

But he warned that if the tension on markets continued, the country might not be able to return to borrow normally next year and would again need rescue funding.

At Deutsche Bank, economist Gilles Moec said that Portugal's good relationship with its creditors "is going to significantly sour".

Auditors from the IMF, EU and ECB arrive in the middle of July to assess progress on reforms, notably on a radical reform of the state which the resigning foreign minister was piloting.

Portugal tested its standing on the bond market in May, making its first-long-term bond issue since being rescued two years ago, and raised 3.0 billion euros ($3.88 billion) for 10 years at 5.669 percent.

Once bonds are issued, with a fixed rate of return for the life of the bond, they may be traded. If perceived risk rises, some investors sell the bonds, the price falls and the fixed rate automatically rises in relation to the new lower market price.

This new rate or yield, indicates what the government would have to pay to borrow the next time it issues bonds.