Portugal hit again by fear of default and downgrades

Markets showed their disappointment at last week's inconclusive EU Summit by marking Portuguese sovereign debt down once again, while a leading credit ratings agency has downgraded Portugal's largest banks and warned it may do the same to its sovereign debt rating, the second time in a week.

With market interest rates on Portuguese debt close to 8 per cent and its bonds close to "junk" status, few investors now believe Portugal can avoid a bailout. Failure to agree a plan to boost the current EU rescue fund last week, plus demands from Ireland to renegotiate its deal has also added to the febrile atmosphere; meanwhile, Portugal is run by a caretaker government.

The euro itself, though, remained relatively stable, buoyed by hopes of an interest rate rise by the European Central Bank (ECB) next week, and indeed hit a five-month high against sterling on jitters about the prospects for UK growth ahead of today's announcement of revised fourth-quarter GDP data.

The ECB revealed yesterday that it had resumed its sovereign bond purchase programme – widely regarded as a thinly veiled aid programme for the eurozone's distressed peripheral economies.

Some €432m (£380m) of sovereign bonds were purchased by the ECB last week, the first such operation for three weeks. The move seems merely to have confirmed investors' fears about national governments' ability to fund themselves without help from the central bank. The ECB itself has made little secret of its desire to end such "emergency" operations and to stop indirect aid to national governments through the provision of cheap liquidity to "addicted" private banks, in effect as a conduit by states locked out of capital markets.

Such trends have prompted the Standard & Poor's (S&P) agency to slash the credit ratings of Portugal's five largest banks and warned that it could cut the country's sovereign debt rating for a second time in a week following the resignation of the Prime Minister, Jose Socrates. S&P pushed Portugal's long-term sovereign debt credit rating down two notches to "triple B" last Friday, after the collapse of the Socialist government.

A European summit at the end of last week postponed a decision on expanding the existing bailout to June, following a request by the Finnish government, which faces national elections soon.

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