Portugal crisis deepens even as EU agrees new eurozone fund

The European Union summit yesterday agreed a package of measures designed to bolster the eurozone's defences against the debt crisis which now seems certain to claim Portugal as its latest victim.

Before the collapse of the Portuguese government on Wednesday, the summit deal would undoubtedly be considered a good day at the office for the 27 EU leaders, but the near certainly that Portugal will now be forced to follow Greece and Ireland in appealing for a multi-billion euro bailout dampened the congratulatory mood.

Portugal's woes worsened as the leaders were finalising their "comprehensive package" of stability funds and policy coordination.

The ratings agencies Standard & Poor's and Fitch both cut Portugal's rating following parliament's rejection of Prime Minister Jose Socrates' latest austerity plan, which precipitated the resignation of his government. In a response to this, global bond markets pushed up the interest that Lisbon has to pay on the country's burgeoning debt, with rates on the benchmark 10-year bonds breaking through the symbolic eight per cent level.

Portugal cannot afford to pay those rates for much longer and its long efforts to avoid a bailout from the EU and IMF now seem doomed. Estimates of how much that bailout will be start at about €70bn (£62bn), well within the limits of the ¤440bn emergency rescue fund which the EU leaders agreed to strengthen on Friday.

"If Portugal asks for help, then it would be assumed that this would happen shortly and, in that case the rescue shield would be enough," said Luxembourg Prime Minister Jean-Claude Juncker, who chairs meetings of the eurozone.

The fear in Brussels is that Portugal will not be the last domino to fall. Although Spain's finances are healthier than its Iberian neighbour, Madrid is still struggling to contain the impact of its burst property bubble, which has left several banks teetering and pushed unemployment over 20 per cent.

Spanish politicians were quick to play down the risk of contagion. "We are confident that the political situation in Portugal won't lead to financial instability," Prime Minister Jose Luis Rodríguez Zapatero said in Brussels.

British Prime Minister David Cameron declined to comment on Portugual's situation, but he welcomed the measures adopted at the summit to shore up the eurozone, stressing that a "a strong eurozone is in British national interest" as 40 per cent of UK trade is with the currency bloc.

Under the summit deal, the EU will set up a permanent, €500bn bailout fund to replace the temporary war chest that is due to expire in 2013. It also agreed to discuss closer fiscal co-ordination and new rules for closer economic monitoring of each other's economies, in an effort to prevent governments building up the sort of debt levels that triggered the current crisis.

"Very far-reaching and ground-breaking decisions were made at this summit," said German Chancellor Angela Merkel. "We have ensured there will be durable support for the euro."

If Spain were to become the next domino to fall, however, serious doubts would be raised about the viability of the euro, given the mounting discontent among voters in Germany, Finland and the Netherlands about the transfer of funds to eurozone partners.