Markets make Portugal pay heavy price for loan

Portugal's cost of borrowing soared by 80 per cent yesterday, as the eurozone's ongoing debt crisis took centre stage again with the festive season barely over.

The Portuguese government successfully sold €500m (£425m) of bonds repayable in six months but the yield – or cost in interest to its taxpayers – was 3.68 per cent. That compares with the 2.04 per cent the country paid for a similar auction in September. The yield was as low as 0.59 per cent as recently as a year ago.

The punitive rates were a reflection of the continued fears that Portugal will be the next domino to fall by following Ireland and Greece in having to seek a bailout from the EU and the International Monetary Fund. The country's Prime Minister, Jose Socrates, has repeatedly said Portugal will be able to continue to finance its debt on the international markets and will not need to take this step, despite the rates it is being required to pay.

Analysts were at least reassured by the fact that demand was strong – the auction was 2.6 times covered – though the real test will come when the country seeks longer-term financing. The date for this has yet to be announced – officials are revising the borrowing calendar to take account of an austerity budget on Portugal's financing requirements.

However, it is widely expected that Portugal will test the markets on 12 January. That is just a day before Spain launches an auction of 3.25 per cent bonds for repayment in April 2016. Spain is the biggest of the debt-ridden and economically weak nations on the fringes of Europe, and were it to face similar problems to Ireland or Greece, the consequences would be dire. Its economy is bigger than that of theirs and Portugal's combined.

Further auctions of debt by Spain and Italy, another country causing concern, will take place later this month. Analysts note that banks with the ability to tap the bond markets have taken advantage of the lull in issuance over the Christmas period to get bond issues of their own away before any fresh turbulence afflicts the markets. They include Deutsche Bank and Rabobank.

Philip Shaw, an economist at Investec, said this amounted to a sensible strategy on their part. He also said there were grounds for hoping that Portugal might avoid the fate of Greece or Ireland. "Portugal is a weak and uncompetitive economy, not least because it failed to liberalise its labour market after joining the euro. These are structural problems but they are not terminal. Portugal does not have the same problem with its banking system as Ireland and nor is it a basket case like Greece."

David Buik, a partner at BGC Partners, said: "The issuance of these short-term bonds comes at a huge premium when compared to last time but is a smart move because it will buy time. Issuing longer-dated bonds at competitive rates is extremely difficult at the moment."

There are no Portuguese bond redemptions due until April. Repayments that month and in June come to about €9.5bn (£8.1bn). The rating on Portugal's debt was cut one level by Fitch on 23 December, which warned of a "deteriorating" economic outlook.