ECB Gives Portugal Temporary Lifeline, Traders Say

Germany and France are pressing Portugal to take an EU-IMF bailout as economic contagion continues to spread throughout Europe. The potential rescue package comes on the heels of similar deals for Ireland and Greece. While Portugal and other European nations including Spain, Italy, and Belgium may not need assistance, such speculation demonstrates clear weakness in European debt financing, which strongly affects the international economy.

By William James and Jan Strupczewski

January 10, 2011

The European Central Bank threw Portugal a temporary lifeline on Monday by buying up its bonds, traders said, as market and peer pressure mounted for Lisbon to seek an international bailout soon.

A senior euro zone source told Reuters on Sunday that Germany, France and other euro zone countries were pushing Portugal to seek an EU-IMF assistance program, following Greece and Ireland, in a bid to prevent contagion spreading to much larger Spain, the fourth biggest economy in the euro area.

The interest rate premium on Portuguese sovereign debt fell on Monday after rising sharply late last week as traders said the ECB intervened to buy government bonds on the secondary market.

"They're buying five-years and 10-years in Portugal, whatever people are offering really," one trader said.

Another trader said the ECB appeared to be buying Greek and Irish bonds too. EU sources say the central bank has not yet bought Spanish government debt.

The euro zone source said Lisbon would need between 50 billion and 100 billion euros ($64.5-$129.1 billion) in loans, similar to Ireland, which accepted an 80 billion euro EU-IMF rescue in December after a banking crisis caused by a burst real estate bubble lumbered the state with huge liabilities.


German Finance Minister Wolfgang Schaeuble denied that Berlin was pushing anyone to seek assistance, but he said it was defending the euro.

Spanish Economy Minister Elena Salgado said Portugal did not need to apply for aid because it was meeting its commitments to reduce its budget deficit. And the European Commission said no discussion was currently under way on assistance for Portugal or any other country.

But economists and market analysts said it was widely regarded as only a matter of time before high-deficit Portugal, with a stagnant economy that has lost competitiveness since joining the euro area, had to seek aid.

"If market spreads keep rising, Portugal has little chance of escaping a bailout," said Laurence Boone, research director at Barclays Capital in Paris.

Deutsche Bank economists Gilles Moec and Marco Stringa said in note that the Lisbon government would have to significantly "over-issue" debt in the first four months to avoid a sharp deterioration in its cash position while Portuguese banks will face a peak in their refinancing needs in January and February.

"It would be rational for Portugal to call for external help sooner rather than later," they said.

European finance ministers are due to consider a more comprehensive response to the continuing debt crisis at their next monthly meeting on January 17-18.

A German Finance Ministry spokeswoman said Portugal was not on the agenda, but the euro zone source said informal exploratory talks had already begun.

A senior euro zone source said the comprehensive approach would involve:

-- implementing austerity measures to reduce fiscal deficits, which was already broadly on track;

-- completing the repair of the European financial system with tougher bank stress tests due in the first quarter;

-- reinforcing the euro zone's financial safety net, which is subject to intensive negotiation with Germany;

-- completing the reform of euro zone economic governance by pushing the required legislation through the council of EU finance ministers and the European Parliament; and

-- implementing structural economic reforms of labor markets and pension systems, on which the European Commission is expected to make country-specific recommendations this week.


The toughest item on that agenda is the strengthening of the financial backstops because of German resistance to increasing the size of the 440 billion euro European Financial Stability Facility, EU sources say.

Berlin has also opposed allowing it to be used more flexibly to provide standby credit lines or to buy government bonds or fund bank recapitalization before a country hits the buffers.

Portuguese Prime Minister Jose Socrates said last Friday his country had no need of outside assistance because it was ahead of schedule in reducing its budget deficit.

Socrates, who heads a minority socialist government, is stubbornly avoiding a bailout, mindful of the traumatic history of Portugal's two International Monetary Fund rescues since its return to democracy in 1974.

The memory of the IMF's involvement, in 1977 and in 1983, is so etched on the Portuguese psyche that the country's media is not even mentioning that it would primarily be the European Union that would finance any bailout this time.

Many Portuguese remember the loss of sovereignty and the hardship the country went through during those periods.