Portuguese bonds reeled from their worst day since June on Friday, before a ratings review that will serve as a prelude for a more crucial test of the country's creditworthiness next month, according to a report by Reuters.
Standard and Poor's did not alter its junk rating for Portugal on Friday. But any warnings on its economy, such as those from Portugal's budget watchdog on Thursday, may feed fears that DBRS will remove the country's last investment-grade rating, which Lisbon needs to qualify for ECB bond purchases on Oct. 21.
Losing the support of the central bank could raise the prospect of a second bailout for Lisbon in five years, as its anti-austerity government battles a banking crisis and is at loggerheads with Brussels over its budget deficit.
Local media reported on Thursday that Prime Minister Antonio Costa rejected claims there will be another bailout but analysts at Commerzbank said the mere mention of the word had spooked investors.
"It may become a self-fulfilling prophecy," Commerzbank strategist David Schnautz said.
While all other euro zone yields fell on Friday, Portugal's 10-year yields rose 4 basis points to 3.45 percent , extending a rise of some 15 bps on Thursday after the country's budget watchdog warned of a slowdown in the economy and a deficit that would miss EU targets.
Thursday's sell-off marked the biggest daily rise in yields since Britain's vote to leave the European Union rattled markets on June 24.
It is against this backdrop that investors are giving such keen attention to a routine assessment of the country's rating by Standard and Poor's, due to be released after markets close on Friday.
Standard & Poor's currently rates Portugal below investment grade at BB+, with a stable outlook. But it said at its last review in March that it expected Lisbon's recovery to moderate throughout 2016.
Another agency Moody's, which has the same rating and outlook as S&P, said this week that a fragile banking sector, stuttering economy and high debts were exerting downward pressures on the country's rating.
Similar warnings by S&P would not bode well for bigger tests next month.
First, Lisbon's coalition government has until October 15 to submit its 2017 budget to the European Commission. Analysts say keeping all parties happy while tightening the belt to meet EU demands may prove difficult.
If this creates any more friction with Brussels, it could prove ominous for the second big test a week later, when DBRS assesses Portugal's rating.
DBRS's BBB (low) rating for Portugal, the only investment-grade rank of the four ECB-recognised rating agencies, has been a vital prop, allowing Portuguese bonds to remain part of the European Central Bank's €1.7 trillion buying programme.
The rating carries a stable outlook, giving Lisbon some breathing space, but DBRS's sovereign ratings chief told Reuters last month that pressures are building on Portugal's creditworthiness.
"A number of factors are conspiring to see Portugal have by far the highest country-specific risk sensitivity of any of the major euro zone countries," Rabobank said in a note on Friday.
Comments
Perhaps that's a bit too exciting and far too challenging for them.