UPDATE 2-S&P cuts Portugal credit rating, warns of further downgrade

* S&P says political uncertainty prompts credit downgrade

* Warns another cut likely next week depending on bailout
fund

* Move comes a day after Fitch cuts Portugal by 2 notches

* Euro dips but quickly regains lost ground

(Adds analyst comment)

By Ian Chua

SYDNEY, March 25 (Reuters) – Standard & Poor’s downgraded
Portugal’s credit ratings by two notches to BBB on Friday and
warned it could cut it again by one notch as early as next week
depending on the final shape of the euro zone bailout fund.

S&P, which followed a two-notch cut by Fitch on Thursday,
said the collapse of Portugal’s government has increased
political uncertainty, hurting market confidence and potentially
raising refinancing risk.

Whether there will be another downgrade hinges on the design
of the bailout fund, or European Stability Mechanism (ESM), the
S&P said.

“Based on current information and expectations, we could
lower the ratings on Portugal again by one notch once the
details of the ESM are officially announced,” S&P said in a
statement. “Such a rating action could take place as early as
next week.”

The agency said it would cut its rating again if the ESM
raised the likelihood that Portuguese government bondholders
become subject to a restructuring, or if the local market
suffered a drop in trading liquidity.

The euro dipped to a session low around $1.4150 after
the S&P announcement from $1.4171 late in New York on Thursday
before recovering completely to $1.4179, indicating markets had
already priced in the cut following Fitch’s move.

“The markets have expected that. The market is also
expecting that at some stage Portugal will seek a bailout from
the EU,” said Daniel Brdanovic, senior manager Treasury at HSBC
in Auckland.

END GAME NEARING?

Senior euro zone officials said Portugal was likely to need
60-80 billion euros in assistance from the EU rescue fund and
the International Monetary Fund. No talks have begun yet and
will anyway have to wait until a new government is formed.

“Mixing political crisis with a lack of austerity package
and a bond market that is unwilling, that is not a situation
that can carry on for very long at all, so I think we’re moving
towards that end game where Portugal is forced to seek help,”
said Robert Rennie, strategist at Westpac Bank.

Despite Portugal’s rejection of austerity measures, S&P
predicted the new government would eventually have to agree to
the steps.

“We expect that a successor government would have no choice
but to adopt some version of these reform proposals, given
investors’ apparently reduced appetite for Portuguese government
debt, though perhaps on a delayed basis,” S&P credit analyst
Eileen Zhang said.

European leaders agreed on Thursday to increase their
financial rescue fund to the full 440 billion euros by June, but
avoided discussion of Portugal, which is under pressure to seek
a bailout following the resignation of its prime minister.

Having said for weeks that they would agree a “comprehensive
package” to tackle the euro zone debt crisis by the end of
March, the leaders ended up delaying a final decision on
boosting their safety net until mid-year.

The Portuguese upheaval underscored the wealth of political
obstacles the single currency bloc faces in trying to solve a
debt crisis that has deepened over the past year.

S&P said it could affirm the ratings at ‘BBB/A-2’ if “our
current views about the ESM and its potential effect on
Portugal’s sovereign debt were to change as a result of further
developments and if we were to take the view that the downside
and upside risks to our forecasts are broadly balanced.”

(Additional reporting by Mantik Kusjanto; Editing by Balazs
Koranyi)

UPDATE 2-S&P cuts Portugal credit rating, warns of further downgrade