Portugal's debt worries worsen as bond yields rise

LISBON — Portugal's bond yields rose to euro-era record highs on Friday, driven by market fears about the debt-laden country's economic health and wider concerns about the eurozone's financial stability.

Investors are worried the government won't be able to meet its debt obligations and may need a bailout like those provided to Greece and Ireland last year.

Borrowing rates edged up across much of the rest of Europe after a eurozone growth figure was revised down, but traders were by far most worried about Portugal — its 10-year government bond yield spiked above 7.1 percent.

The nervousness triggered a steep drop in Portuguese share prices. The Lisbon benchmark stock index closed down 3 percent, dragged lower by a sharp fall in shares in Portuguese banks which are exposed to national debt.

Portugal is one of the 17-nation eurozone's smaller members, accounting for less than 2 percent of the bloc's gross domestic product. But its difficulties could stoke the continent's debt crisis, especially by placing pressure on its much larger neighbor Spain, which also has debt problems.

"While the relatively small size of Portugal's funding needs suggests that a Portuguese bailout will not exert a huge amount of pressure on the eurozone support fund, it will raise the risk of a speculative attack on the Spanish debt market," Jane Foley, senior currency strategist at Rabobank International, wrote in an analysis.

The Bank of Tokyo-Mitsubishi noted that whereas Ireland's loan maturity average is seven years at an average cost of 5.8 percent, Portugal's 7-year bonds are now trading at 6.6 percent.

Portugal aims to raise euro1.25 billion ($1.64 billion) next week by auctioning off 3-year and 9-year bonds in a key test of investor confidence.

The chief economist of Germany's biggest bank said Portugal won't manage to regain sufficient trust among investors and should move swiftly to tap Europe's euro750 billion rescue fund before the problem worsens.

"The euro crisis has made a Christmas break, but it's back with the new quarter," Deutsche Bank AG's Thomas Mayer told foreign journalists in Berlin.

The government insists it doesn't need financial help, though, and says its debt reduction plan is on track.

Prime Minister Jose Socrates said Friday that state revenue was higher than forecast last year and spending was lower than expected, helping Portugal to meet its budget deficit target of 7.3 percent. Meanwhile, the economy is estimated to have grown by at least 1.3 percent in 2010.

Socrates said those figures "should help instill confidence in the markets."

However, analysts expect an austerity plan featuring tax hikes and pay cuts to cast Portugal into recession this year.

That would hurt tax revenue and place further stress on the budget which is already being drained by high interest rates on its borrowings and increased welfare payments resulting from a jobless rate that has risen to 11 percent.

Fears that economic growth in Europe will be slow and drag on governments' efforts to raise income were heightened by a downward revision to the eurozone's GDP growth in the third quarter of 2010. Eurostat, the EU's statistics agency, said output rose by only 0.3 percent, down on the previous estimate of 0.4 percent and way below the 1 percent growth recorded in the second quarter.

Business investment fell and personal spending declined, suggesting the region is in for a prolonged period of weak growth and government belt-tightening will be harder than expected.

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Juergen Baetz in Berlin contributed to this report.