By Anchalee Worrachate
March 23 (Bloomberg) -- For most of this month, traders wondered why the European Central Bank made little attempt to curb rising yields for the region’s most indebted nations. Their conclusion is Portugal may be next to get a bailout.
“By staying away from the market, the ECB made it quite clear to Brussels this is their problem to sort out,” said David Owen, chief European economist at Jefferies International Ltd. in London. “This is a fiscal problem which should be addressed by politicians, not a central bank whose mandate is to handle the monetary policy.”
The ECB’s reluctance to intervene ahead of the European Union summit on March 24-25 has stoked speculation about a financial rescue for Portugal. When traders said the central bank purchased Portuguese debt at the end of last week, the nation’s funding costs were at a euro-era record, with the yield on five-year securities rising today to 8.14 percent.
“We believe that Portugal will need to seek a bailout, and it might happen as soon as this week,” said Pavan Wadhwa, head of global interest-rate strategy at JPMorgan Chase & Co. in London. “It’s clear Portugal can’t survive on its own at these levels of borrowing costs.”
Prime Minister Jose Socrates has said his government stands ready to debate deficit-cutting measures with opposition parties as he tries to avoid a “political crisis,” early elections and a potential bailout.
The Portuguese parliament will discuss its so-called stability and growth program at 3 p.m. today. The Communist Party plans to present a resolution against the plan, Bernardino Soares, the party’s parliamentary leader, said yesterday. The Social Democratic Party, the biggest opposition group in parliament, also is against the steps backed by Socrates’s party.
Cost Cutting
Finance Minister Fernando Teixeira dos Santos presented deficit cuts on March 11 equal to 4.5 percent of the country’s gross domestic product over three years through 2013, including a reduction in pensions of more than 1,500 euros ($2,134) a month and further cuts in tax benefits.
Portugal’s efforts to put its finances in order are complicated by a deteriorating economy. The government estimated March 21 that the country’s gross domestic product will contract
0.9 percent this year as investments drop and spending is reduced to narrow the budget gap.
To stabilize bond yields rocked by the region’s debt crisis, the ECB has been purchasing sovereign bonds in the open market, including those from Greece, Ireland and Portugal, since May.
Last Resort
The central bank has been forced to maintain its role as a buyer of last resort after EU leaders decided March 12 that the European Financial Stability Facility, the region’s bailout fund, will acquire bonds directly from governments of countries in a program, and not from the secondary market.
Wadhwa estimates that every 1 billion euros per week of ECB bond purchases results in 40 to 60 basis points of tightening in the so-called weighted peripheral spread. The ECB stepped in to buy Portuguese securities as recently as March 18, according to two people with knowledge of the trades who declined to be identified because the transactions are confidential.
Portugal is raising taxes and implementing the deepest spending cuts in more than three decades to convince investors it can curb the deficit and avoid a bailout after the Greek debt crisis led to a surge in borrowing costs for high-deficit euro nations.
Investors demand 434 basis points of extra yield to hold 10-year Portuguese notes rather than benchmark German bunds of similar maturity. The spread is approaching the euro-era record of 483 basis points reached November 11. The average was 282 over the past decade.
Swaps Market
The cost of insuring Portuguese government debt surged 42.5 basis points to 540 yesterday, according to CMA prices for credit-default swaps. The contracts have climbed from 387 basis points on Feb. 2 and are now close to the Jan. 10 record of 555.
The Markit iTraxx SovX Western Europe Index of swaps on 15 governments jumped 9.5 basis points to 175, the biggest increase since Jan. 6.
EU leaders meet at the end of this week to endorse the retooled package for peripheral Europe. The measures include allowing the EFSF to buy debt directly from governments for the first time and lowering borrowing costs for Greece. The primary- market purchases will just be used as an exception and only in return for austerity commitments.
Expanding the fund’s mandate to take over the ECB’s task was resisted by Germany, the Netherlands and Austria even as French officials had indicated backing for such a step. Refusal to let the money to be used for bond purchases on the market is “not in line with what we’ve recommended,” ECB President Jean- Claude Trichet told a European Parliament committee in Brussels on March 21.
‘One-Off Loan’
“As thing stands, it’s conceivable the EFSF could make a one-off loan of around, say, 2 billion euros to Portugal along with conditionality,” said Ciaran O’Hagan, head of European interest-rate strategy at Societe Generale SA in Paris. “It could also buy their bonds in the primary markets. That’s possible although there’s nothing to indicate that’s a chosen route for now.”
The ECB probably will do the “bare minimum” on bond purchases, said Owen of Jefferies.