The European Central Bank threw Portugal a temporary lifeline on Monday by buying up its bonds, traders said, as market and peer pressure mounted for Lisbon to seek an international bailout soon.
A senior euro zone source said on Sunday that Germany, France and other euro zone countries were pushing Portugal to seek an EU-IMF assistance program, following Greece and Ireland, to prevent contagion spreading to much larger Spain, the fourth biggest economy in the euro area.
The Reuters report drew official denials from German Chancellor Angela Merkel on down, but economists and market analysts said it was only a question of time before Lisbon too would need a rescue.
"We never pushed countries into doing something and we will not do this either," Merkel said on a visit to Malta. States would have to decide for themselves whether they required help, she added.
The interest rate premium on Portuguese sovereign debt fell back on Monday after rising sharply late last week as traders said the ECB intervened to buy government bonds on the secondary market.
One trader said the ECB appeared to be buying Greek and Irish bonds too. EU sources say the central bank has not yet bought Spanish government debt.
The ECB has bought 74 billion euros ($95.53 billion) in troubled euro zone sovereign bonds since it began intervening to stabilize the market last May. Last week's purchase of 113 million euros was the smallest since October.
But even at their peak, ECB purchases have only bought a short-term respite from market pressures.
The euro fell to a four-month low against the dollar and European shares also fell sharply, giving back some of last week's gains, as worries about the debt crisis returned to center stage ahead of this week's bond auctions.
One senior euro zone source told Reuters on Sunday that Lisbon would need between 50 billion and 100 billion euros ($64.5 billion to $129.1 billion) in loans, similar to Ireland, which accepted an 80 billion euro EU-IMF rescue in December.
"LITTLE CHANCE OF ESCAPING"
Economists said high-deficit Portugal, with a stagnant economy that has lost competitiveness since joining the euro area, was inching inexorably toward seeking aid.
"If market spreads keep rising, Portugal has little chance of escaping a bailout," said Laurence Boone, research director at Barclays Capital in Paris.
Deutsche Bank economists Gilles Moec and Marco Stringa said in a note that the Lisbon government would have to significantly "over-issue" debt in the first four months to avoid a sharp deterioration in its cash position while Portuguese banks will face a peak in their refinancing needs in January and February.
"It would be rational for Portugal to call for external help sooner rather than later," they said.
Portugal and Spain return to bond markets this week for the first time in 2011. The result of Lisbon's auction of 1.25 billion euros in five- and 10-year bonds on Wednesday could tip the country toward seeking an early bailout if yields soar, IHG-Global Insight economist Diego Iscaro said.
European finance ministers are due to consider a more comprehensive response to the debt crisis at their next monthly meeting on Jan. 17-18. A German finance ministry spokeswoman said Portugal was not on the agenda, but the euro zone source said informal exploratory talks had already begun.
The source said the comprehensive approach would involve:
• implementing austerity measures to reduce fiscal deficits, which was already broadly on track;
•completing the repair of the European financial system with tougher bank stress tests due in the first quarter;
• reinforcing the euro zone's financial safety net, which is subject to intensive negotiation with Germany;
• completing the reform of euro zone economic governance by pushing the required legislation through the council of EU finance ministers and the European Parliament;
• implementing structural economic reforms of labor markets and pension systems, on which the European Commission is expected to make country-specific recommendations this week.
BONE OF CONTENTION
The most contentious item on that agenda is the strengthening of the financial backstops because of German resistance to increasing the size of the 440 billion euro European Financial Stability Facility, EU sources say.
Berlin has also opposed allowing it to be used more flexibly to provide standby credit lines or to buy government bonds or fund bank recapitalization before a country hits the buffers.
Portuguese Prime Minister Jose Socrates said last Friday his country had no need of outside assistance because it was ahead of schedule in reducing its budget deficit.
Socrates, who heads a minority socialist government, is mindful of the traumatic history of Portugal's two International Monetary Fund rescues since its return to democracy in 1974.
The memory of the IMF's involvement, in 1977 and in 1983, is so etched on the Portuguese psyche that the country's media does not even mention that it would primarily be the European Union that would finance any bailout this time.
Many Portuguese remember the loss of sovereignty and the hardship the country went through during those periods.
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