EURO GOVT-Portuguese bonds stable, bailout terms key

* Bailout terms key for Portuguese yields, uncertainty high

* Bunds slide as ECB seen hiking further

* Markets see some chance of next rate rise in June

By Marius Zaharia

LONDON, April 8 (Reuters) – Portuguese bonds were stable on
Friday, with investors expecting lenders to set tough bailout
terms and complicate the task for the upcoming government, while
Bunds fell as markets brought forward bets for the timing of the
next rise in euro zone interest rates.

Euro zone finance ministers meet on Friday to discuss
Portugal’s aid request and are expected to ask for difficult
fiscal conditions in return, keeping uncertainty high over its
ability to grow out of its debt crisis.

News that the European Central Bank encouraged Portugal to
seek aid and comments from finance ministers on Friday pointed
to Lisbon being asked for tougher budget cuts than those whose
rejection by parliament last month prompted a political crisis.

With the rally earlier this week losing steam, uncertainty
will probably keep Portuguese bond yields close to Irish ones
after the spread between the two narrowed by about 200 basis
points since the March government collapse in Lisbon.

“I don’t imagine the situation is going to be particularly
rosy for Lisbon, (EU) partners have been urging them to seek a
bailout for a long time … so Portugal doesn’t have a choice
and there won’t be an awful lot of negotiation,” said Lloyds
strategist Eric Wand.

ECB President Jean-Claude Trichet kept expectations for
further rises this year in euro zone interest rates alive
following Thursday’s 25 basis point increase to 1.25 percent.

He said the bank would “monitor very closely” risks to
inflation, phrasing which in the past has signaled a pause for a
month before another rise, although he did soften the message
somewhat by stressing Thursday’s hike was not planned as the
first in a series of moves.

A new hike in July is fully priced in, but the probability
priced in by markets for an increase in June has risen.

“June is now looking very much possible and (it is weakening
Bunds as) the ECB looks more aggressive because of that,” one
trader said.

The Bund future (FGBLc1: Quote, Profile, Research) was 41 ticks lower at 120.30.
Ten-year Bund yields (DE10YT=TWEB: Quote, Profile, Research) were 4.8 bps up at 3.462
percent, while the two-year Schatz yield (DE2YT=TWEB: Quote, Profile, Research) stood at
1.889 percent, up 6.7 bps on the day.
Weakness in U.S. Treasuries fuelled by the risk of a
government shutdown after government leaders failed to reach a
budget deal is also feeding into core European markets, traders
said. [US/]

“Ten-year Bund yields will test 3.5 percent very soon
particularly because there’s also weakness in Treasuries,”
Stamenkovic said.

IRELAND BRIGHTER

This week’s outperformance by Ireland, following a less
gloomy view on its banks after the stress tests last Thursday,
can be taken as a sign that Portuguese yields may surpass
Ireland’s in the longer-run.

“At the moment people will probably trade the two on top of
each other … but if the banking problem can be contained the
Irish economy is probably more vibrant than Portugal’s,” said
Lloyds’ Eric Wand.

Irish and Greek yields had risen again after a brief dip
immediately after their bailouts as markets began to price in
the risk that their debt will eventually be restructured under
the permanent euro zone bailout mechanism due to start operating
in 2013.

The Portuguese/German ten-year bond yield spread
(PT10YT=TWEB: Quote, Profile, Research) (DE10YT=TWEB: Quote, Profile, Research) was stable at 546 basis points.

Portugal is expected to receive aid of up to 85 billion
euros, and a figure much higher than that could increase
pressure on bond prices as it would point to deeper problems
than previously thought.

“The market will largely shrug off any figure unless it’s
above 100 billion euros,” said Nick Stamenkovic, bond strategist
at RIA Capital Markets. “It shows the extent to which they need
external assistance.”
(Editing by Patrick Graham)

EURO GOVT-Portuguese bonds stable, bailout terms key