EU leaders fight to stop Portugal slipping into eurozone mire

Financial contagion spreads to Spain as government bond yields soar again
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Europe's most senior political leaders were forced yesterday to officially deny mounting speculation that an Ireland-style bail-out is imminent for Portugal and that Spain will soon need a similar rescue.

As rumours spread across financial markets that talks over a bail-out for Portugal had begun, Jose Manuel Barroso, the President of the European Commission, said: "It's absolutely, completely false – every reference for an aid plan for this country. It has neither been asked for and neither have we suggested it. It is absolutely false."

Mr Barroso's denials were welcomed in Lisbon, where Jose Socrates, the Portuguese Prime Minister, also felt obliged to intervene following fevered speculation. Mr Socrates, whose latest budget plans were approved by his Parliament yesterday, said: "The country does not need any help."

Jose Luis Rodriguez Zapatero, the Spanish Prime Minister, also spoke out, amid concern that further difficulties for Portugal would spill over to his country, which is more exposed to its neighbour's debt than any other member of the eurozone. "I should warn those investors who are short selling Spain that they are going to be wrong and will go against their own interests," Mr Zapatero said.

With German politicians also rejecting speculation about a bail-out of Portugal, eurozone ministers sought to present a united front yesterday.

However, investors on European debt markets appeared unconvinced by the show of unity, with further sell-offs of both Portuguese and Spanish bonds. The yield on 10-year Portuguese government bonds rose to 7.12 per cent, while the equivalent bonds in Spain are now yielding 5.28 per cent. In both cases, the premium that investors demand to hold the debt compared with safer German government bonds now stands at a record high.

The continued surge in bond yields in the most vulnerable members of the eurozone – yields on both Greek and Irish debt also rose again yesterday – suggests that hopes the bail-out of Ireland would draw a line under the crisis have yet to be fulfilled.

The euro also continued to fall in value yesterday, to below $1.32 at one stage. The value of the European single currency has fallen by 3.5 per cent this week alone.

Analysts warned that the sense of panic was beginning to take on a life of its own. "The moment you have even a flicker of doubt about default risk, it becomes rational to reduce positions in a larger country like Spain purely on the grounds of diversification," said Matt King, the global head of credit strategy at Citigroup.

Nor do the official denials of talksbetween Portugal and the EU seem to have calmed investors, who saw similar statements in the run up to thebail-out of Ireland, the details of which are still being negotiated. Two-thirds of 50 economists polled by Reuters this week now believe that an EU bail-out of Portugal is inevitable.

"Our data shows there are noticeable bond outflows from Spain and Italy, which suggests investors are becoming more unsettled," said Simon Derrick, head of currency research at Bank of New York Mellon.

British economists are becomingincreasingly concerned about the effect of the eurozone crisis on this country's recovery from recession. Roger Bootle, of Capital Economics, warned that the effect on British exports – 14 per cent of which go to Portugal, Ireland, Italy, Greece and Spain – would be severe. "If, as we fear, the eurozone crisis continues to intensify, hopes that the external sector will offset theeffects of the UK's own fiscal crisis may quickly fade again," he warned.