EURO GOVT-Portuguese yields hit new highs, contagion risk low

* Portuguese yields seen rising towards Irish levels

* Spain insulated now, steepening curve seen a good sign

* EU summit seen lacklustre, clouded by Portugal crisis

By Marius Zaharia and Emelia Sithole-Matarise

LONDON, March 25 (Reuters) – Portuguese government debt
yields hit new euro-era highs on Friday, pushed by credit
ratings downgrades and as an EU summit delayed finalising an
anti-crisis package, but contagion risks were seen limited.

Standard & Poor’s two notch downgrade has brought Portugal’s
rating to BBB, two notches below Ireland’s, whose yields trade
200-300 basis points higher, prompting views among traders that
the two countries’ yield curves will attempt to converge.

The pressure on Portuguese debt did not spread to other
markets, though, signalling contagion risk was seen low for now
as investors continued to be heartened by Spain’s labour and
banking reforms, albeit eagle-eyed for signs of fiscal slippage.

“There have been good (Spanish) initiatives in the area of
structural reforms in the pensions and labour markets, they also
made an attempt to address the issue of the banking system,”
said Kommer van Trigt, a bond fund manager with Robeco Group.

Robeco Group, which manages about 40 billion euros in fixed
income assets globally, has been trimming exposure to Spanish
debt. It does not hold Greek, Irish or Portuguese debt, he said.

“One issue that we are struggling with is what growth can
you expect from a country going forward given the harsh measures
that were necessary. If we were surprised on the upside by the
developments in Spain that would make us more positive on
increasing our exposure,” he said.

Portuguese 10-year yields (PT10YT=TWEB: Quote, Profile, Research) rose through 8
percent for the first time since the launch of the euro, pushing
spreads over benchmark German Bunds to 479 basis points, while
five- and two-year yields were also testing fresh records.

“There is clear scope for Portugal coming under yet greater
strain should the country’s politicians opt to defer requesting
a bailout in favour of campaigning for a likely upcoming
election,” said Richard McGuire, a strategist at Rabobank.

Irish debt was also set to remain under pressure as a
European Union summit deal to soften its bailout terms looked
unlikely. The 10-year Irish/German bond yield spread widened
some five bps to 689 bps.

In contrast, Spanish bond yield spreads versus Bunds
(ES10YT=TWEB: Quote, Profile, Research) (DE10YT=TWEB: Quote, Profile, Research) narrowed six bps to 187 bps, its
lowest since mid-February, while a steepening of its 2/10 yield
curve showed markets did not price in a bailout risk.

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^Spanish&Portuguese yield curves: http://link.reuters.com/zac78r Greek, Irish, Portuguese curves: http://link.reuters.com/bec78r Greek, Irish ylds after bailout: http://link.reuters.com/kec78r Euro zone credit ratings: http://r.reuters.com/pyh48r Spreads moves this week: http://link.reuters.com/cuc78r ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

NO CHOICE

Most analysts say Portugal has no other choice than seek for
a bailout soon, which, judging by the reaction in Ireland and
Greece following their international aid agreements, would not
prevent yields from reaching new highs.

“The market thinks that once you’re in a programme it will
be impossible to get out of the programme,” said Donal O’Mahony,
global strategist at Davy Stockbrokers.

“Chances are that you’re going to be in the permanent
programme in 2013, which can impose haircuts on private
creditors … and this is why we see yield curves inverting in
Greece and Ireland and Portugal.”

Portugal’s political crisis clouded a summit of EU leaders,
who agreed to increase the capacity of the EFSF rescue fund only
by June, after having said for weeks that they would agree a
“comprehensive” package by the end of March. [ID:nLDE72O009]

O’Mahony said that EU leaders will not get on top of the
debt crisis unless they would consider ways of intervening to
help sovereigns before those are forced by markets to apply for
financial aid.

Bund futures (FGBLc1: Quote, Profile, Research) settled 17 ticks lower on the day at
122.03, with investors more willing to take risk following
recent surges in equities globally, but the periphery woes
capped losses.

Ten-year Bunds (DE10YT=TWEB: Quote, Profile, Research) yielded 3.27 percent, up 1.2
basis points on the day, while two-year yields (DE2YT=TWEB: Quote, Profile, Research) were
2.8 bps higher at 1.724 percent.
(Graphics by Kirsten Donovan and Scott Barber; Editing by Toby
Chopra)

EURO GOVT-Portuguese yields hit new highs, contagion risk low