Credit rating agency Fitch downgraded Portugal on Friday saying the debt-laden country needed a bailout, while rival agency S&P cut Ireland's rating after bank stress tests revealed another black hole.
Despite a successful Portuguese debt sale on Friday, Fitch slashed its rating to the lowest investment grade rank of BBB-minus.
"The severity of the downgrade by three notches mainly reflects Fitch's concern that timely external support is much less likely in the near term following yesterday's announcement of general elections to take place on 5 June," said Douglas Renwick, Director in Fitch's Sovereign Ratings Group.
"The agency views external support as necessary to bolster the credibility of Portugal's fiscal consolidation and economic reform effort, as well as secure its financing position," Renwick said in a statement.
Earlier Standard & Poor's became the last of the three major rating agencies to strip Ireland of its 'A' rating. However, the one notch cut and stable outlook was less severe than feared and it gave the thumbs up to stress tests which on Thursday showed its four troubled banks needed a further 24 billion euros to be properly capitalized.
Portugal sold 1.645 billion euros of short-dated bonds on Friday, but had to offer an interest rate of 5.79 percent, lower than other current market rates but 2.5 percentage points more than it paid at similar auctions last year.
Lisbon is now having to pay a higher interest rate to borrow money for the next 15 months than Spain is paying to raise funds for 10 years — a clear indication of how much risk investors now attach to Portugal.
Portugal's 10-year bond yields went on rising despite the smooth auction, hitting 8.77 percent, up more than a percentage point in the past week. Ireland's reached 10.1 percent, nearly 6.5 percentage points higher than benchmark German Bunds.
Richard McGuire, a debt strategist at Rabobank, said that while Friday's auction showed Lisbon could still tap the markets if needed, the trend was bleak.
"(Portugal) is fundamentally insolvent — i.e. it is clearly in a situation where debt will have to be issued to cover servicing costs, thereby resulting in a snowballing of liabilities," he said.
S&P, whose rubbishing of a previous "final bill" for Ireland's banking sector sent the country's debt crisis into overdrive last year, said the assumptions underlying the latest round of tests of bank resilience were robust.
But rival agency Fitch took the shine off S&P's modest downgrade when it warned it could cut its BBB+ rating on the back of weaker growth and a jump in the bank bailout costs.
A Reuters poll of economists gave a consensus forecast of just 0.5 percent growth in Ireland this year, well below the official forecast of 1.7 percent and weaker than the 0.9 percent expected by the European Commission and IMF.
Underscoring the tenuous nature of Portugal's finances, the statistics agency had to restate the 2010 budget deficit on Thursday, increasing the shortfall to 8.6 percent of gross domestic product from 7.3 percent.
The adjustment was down to methodology and will not affect 2011 figures, but still undermines broader confidence, reviving memories of the Greek deficit revision of 2009 that lit the fuse of the euro zone debt crisis.
Financial markets are convinced Lisbon will have to ask the European Union and International Monetary Fund for a bailout.
However, caretaker Portuguese Prime Minister Jose Socrates, who resigned last week after parliament rejected his latest spending cuts, has made it a point of honor not to accept EU/IMF help.
Portugal's president dissolved parliament on Thursday and set June 5 as the date for the next polls, meaning the country is effectively in limbo for two more months.
While Portugal can probably go on funding itself for the next eight weeks — it has to refinance 4.3 billion euros ($6.1 billion) of debt in April and 4.9 billion in June — the cost of doing so is likely to go on being punitively high.
IRISH BANK BILL
The debt crisis in the euro zone has already consumed Greece and Ireland and shows few signs of relenting.
The 24 billion euros extra bank bill for Ireland, which received an 85 billion euro package of aid from the EU and IMF in November, was in line with market expectations and, coupled with the European Central Bank's decision to suspend collateral requirements for loans from Ireland, gave the Irish banking sector a lift on Friday.
The European Commission said it believed the stress tests had been "extremely rigorous" and that there should now be no more surprises lurking for the financial markets.
But Ireland still has accumulated bank liabilities of nearly 45 percent of GDP and will have total debts of well over 100 percent of GDP if forecasts from the stress tests are right.
If the European Central Bank raises interest rates next week as expected, the impact on growth will be even greater in both Ireland and Portugal, driving up debt-to-GDP ratios without the debt increasing.
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