Portuguese crisis relights tension on eurozone bonds

The political crisis in Portugal immediately hit the country's 10-year borrowing rate hard on Wednesday, and also relit tension on the eurozone bond market.

Rates for several countries rose but borrowing costs for Germany and France fell, widening the difference, or spread, between the best and worst performers on the eurozone market.

The risk that the governing coalition in Portugal could break up, with IMF-EU auditors due to arrive there on July 15, pushed up the country's 10-year bond yield sharply to far above the danger level of 7.0 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 7.689 percent.

The 10-year borrowing rate for Greece, the first eurozone country to be bailed out, also rose sharply, to 11.565 percent from 11.099 percent.

The rate for Spain rose to 4.779 percent from 4.624 percent, and for Italy to 4.540 percent from 4.439 percent.

But in contrast the rate on the eurozone 10-year benchmark, the German bund, regarded as a haven in times of tension, fell to 1.649 percent. The rate for France fell to 2.278 percent from 2.313 percent, despite tension in France over public finances.

The surge of the Portuguese rate 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 said: "The risk is limited but the risk exists and this explains the reaction of the markets."

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 on July 15 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.