Portugal's financial plight deepened Wednesday, with borrowing rates jumping higher and stocks slumping after its bonds were downgraded to junk status. Spain and Italy were dragged into the downturn, adding new momentum to Europe's sovereign debt crisis.
Portugal's hopes of slowly emerging from its debt crisis were knocked by ratings agency Moody's, which downgraded Portugal's debt four notches Tuesday and said the country will likely follow Greece in needing a second rescue package.
Portugal took a 78 billion euro ($112 billion) bailout from its European partners and the International Monetary Fund earlier this year after jittery investors began charging it unsustainably steep returns on loans.
After the abrupt worsening of Portugal's financial situation, neighboring Spain immediately suffered a knock-down effect, with Madrid's main stock index down 1.5 percent in midday trading while its bond yields rose. Spain, a much bigger country, up until now has so far managed to dodge major fallout from the continent's fiscal woes.
In Italy, stocks were down 2 percent Wednesday on concerns that current spending cuts were not enough to resolve the country's high debt level.
"The increasing risk is Italy gets caught up further in the contagion, and the bond market vigilantes dictate a more abrupt pace for its adjustment," said Alan Ruskin, an analyst at Deutsche Bank.
The Moody's downgrade triggered new outrage in Portugal, where austerity measures over the past year have included tax hikes, pay freezes and welfare cuts.
Fernando Faria de Oliveira, the head of Portugal's largest bank Caixa Geral de Depositos, which is state-owned, described the downgrade as "immoral and insulting." Antonio Sousa, head of the Portuguese Bank Association, said it was "incomprehensible."
Even Barclays Capital Research said the severity of the downgrade was surprising, adding it "seems more like a reaction to the Greek situation."
Still, the tensions created by the Moody's report were reflected in a Portuguese bond sale. Although the country managed to raise 848 million euros ($1.2 billion) from markets, investors demanded a high return.
The Portuguese debt agency said the yield in the sale of 3-month Treasury bills was 4.926 percent. That was up from 4.863 percent on the same bills in mid-June and not far from the record 4.967 percent on June 1.
The yield on Portuguese 10-year bonds rose to 12.2 percent, while the Lisbon stock exchange fell 2.4 percent with banks leading the decline.
Unicredit economist Tullia Bucco said the threat of possible private sector burden-sharing in Portugal, currently being discussed for Greece, increased the chances of it being shut out of the market beyond 2013, when it hopes to resume bond issues.
Amadeu Altafaj Tardio, a spokesman for the EU's Monetary Affairs Commissioner Olli Rehn, also hit out at the Moody's downgrade, saying "the timing of Moody's decision is not only questionable but also based on absolutely hypothetical scenarios which are not in line at all with the economic program."
"This is an unfortunate episode and it raises once more the issue of the appropriateness of behavior of rating agencies and of their clairvoyance," Tardio said in Brussels.
Portugal faces a daunting task in reducing its debt load — it is in a recession, with its economy expected to contract 4 percent through next year, and unemployment stands at a record 12.4 percent.
A center-right coalition government that took office last month has promised to abide by debt targets and economic reforms demanded in return for the bailout. It has already introduced new austerity measures, including a one-off supplemental tax on personal income this year, and said it would accelerate a privatization program.
The grim economic prospects will likely make it harder for Portugal to settle its debts, propelling it into a downward spiral, and fuel investor worries about the 17-nation eurozone's fiscal health, especially as Greece struggles to restore market confidence.
The government debt agency said last week it wants to raise up to €6.5 billion in Treasury bill auctions over the next three months.
In Spain, the difference between the yield on the 10-year government bonds on the secondary market and the benchmark German equivalent, edged up to 262 basis points Wednesday after closing at 247 Tuesday. The jump was significant, but remained far below the 300-point high reached last week amid fears of contagion from the Greek debt crisis.
Spain's Treasury will test market confidence in the country's ability to handle its debt with three- and five-year bond auctions on Thursday.
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