Portugal Cut to Junk by Moody’s Roils Spain, Italy Bonds as Risk Remains

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Local people read the morning headlines at a newspaper kiosk in Lisbon.

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Photographer: Mario Proenca/Bloomberg

Local people read the morning headlines at a newspaper kiosk in Lisbon. Close

Local people read the morning headlines at a newspaper kiosk in Lisbon.

Photographer: Mario Proenca/Bloomberg

A man sits outside a closed store, near the Cais do Sodre station in Lisbon, Portugal. Close

A man sits outside a closed store, near the Cais do Sodre station in Lisbon, Portugal.

Photographer: Mario Proenca/Bloomberg

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A street cleaner pauses beside her sweeping equipment in a shopping street in Lisbon.

Photographer: Mario Proenca/Bloomberg

Portugal is the second euro country rated non-investment grade by Moody’s Investors Service, joining Greece, after winning a 78 billion-euro ($113 billion) international bailout in May. Close

Portugal is the second euro country rated non-investment grade by Moody’s Investors Service, joining Greece, after... Read More

Photographer: Mario Proenca/Bloomberg

A customer uses an automated teller machine in central Lisbon. Portugal this year joined Ireland and Greece in turning to the EU and the International Monetary Fund for emergency funding after their budget deficits ballooned. Close

A customer uses an automated teller machine in central Lisbon. Portugal this year joined Ireland and Greece in... Read More

Photographer: Patricia De Melo Moreira/AFP/Getty Images

Public administration workers protest against the new budget policies in Lisbon, on November 6, 2010. Close

Public administration workers protest against the new budget policies in Lisbon, on November 6, 2010.

Portugal’s downgrade to junk status and wrangling over the role of investors in a new Greek bailout package fueled concern about the solvency of the region’s high- debt nations, sending their bonds tumbling.

The extra yield investors demand to hold Portugal’s 10-year bonds over German bunds surged 148 basis points to a euro-era record 949 after Moody’s slashed yesterday its credit rating four levels to Ba2, below investment grade. The yield on Italy’s 10-year bond reached the highest in almost three years, while Ireland’s 2-year yield topped 15 percent for the first time.

“It’s a reminder that the sovereign debt crisis does not end with Greece and that risks remain with other nations in addition to Greece,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York.

Moody’s decision may further strain relations between the rating companies and European Union policy makers, who are trying to ensure their plan for investor involvement in a Greek bailout doesn’t trigger a default. Moody’s said that Portugal may need a second aid package and that the Greek plan makes it more likely the EU will require creditors to contribute to that effort, increasing the risk of holding Portugal’s debt.

Portugal saw its financing costs rise at a sale of 848 million euros ($1.2 billion) of three-month bills today. The notes were priced to yield 4.926 percent, more than what Germany pays to borrow for 30 years, up from 4.863 percent at the previous sale.

Default Threat

Talks on investor involvement in the new Greek package are bogging down after Standard & Poor’s and Fitch Ratings both indicated they would cut Greece to default if the EU went ahead with a plan to ask creditors to roll over expiring Greek bonds into new debt. The European Central Bank had pushed the approach as a way to avoid a default rating that might force bank to refuse Greek bonds as collateral, crippling the nation’s lenders that rely on the ECB for their funding.

“The agency sees the participation of the private sector in the Greek debt restructuring as a factor implicitly impacting Portuguese ability to return to the capital markets,” Stefan Kolek, corporate credit strategist at UniCredit SpA, wrote today. “The agency utters what many were fearing: that a participation of the private sector will increase risk aversion in the market.”

Debt Swap

With the credit companies saying a rollover would be default, Germany has revived an approach initially opposed by the ECB to ask investors to voluntarily swap their Greek debt into longer-maturity securities. The Institute for International Finance, which represents more than 400 banks and insurers and is participating in the talks, has also called for buying back Greek bonds in the secondary market to reduce its debt load. That idea was rejected by the EU in March, when it set up a bailout mechanism that was only allowed to buy bonds at auction.

The IIF is hosting a meeting of banks and insurers in Paris today to discuss the proposals for private sector involvement in the Greek aid plan.

The competing ideas underscore how investors and government officials are struggling to devise a role for creditors in a bailout of Greece without triggering a default. The wrangling has pushed back a new aid package, which EU officials had said would be wrapped up by a meeting of euro-region finance chiefs on July 11-12, until September.

That delay may threaten the International Monetary Fund’s contributions to the current Greece aid plan. The IMF has held up its 3.3 billion share of a 12 billion-euro payment due this month until the EU figures out how to ensure Greece remains fully funded.

Influencing Policy

German Chancellor Angela Merkel said the ratings companies shouldn’t be allowed to exert excessive influence on policymakers.

“As far as the rating agencies are concerned, I think it’s important that we -- and by this I mean primarily the troika, the IMF, the European Central Bank and the EU commission -- don’t surrender our own ability to judge,” Merkel told reporters in Berlin yesterday.

Austria’s Chancellor Werner Faymann yesterday said he would move to create a European rating company. The sovereign debt crisis has shown the rating companies lack “local knowledge” and “empathy” for the European condition, he said.

Return to Markets

Moody’s said that Portugal may remain shut out of financial markets beyond 2013 and possibly need a second bailout. It also based its credit rating cut on risk that the nation won’t be able to fully achieve its deficit-reduction target in the three- year aid plan. The rescue, which took effect two months ago, set goals for a budget deficit of 5.9 percent of gross domestic product this year, 4.5 percent in 2012 and 3 percent in 2013. The country had the fourth-biggest deficit in the euro region last year at 9.1 percent of GDP.

Portugal said Moody’s decision ignores the effects of additional revenue measures passed last week. There is a “broad political consensus” backing the execution of the measures that were agreed upon with the EU, ECB and IMF, the Portuguese Finance Ministry said yesterday in

Moody’s rating cut came a month after the country swore in a new government that pledged to implement the latest austerity plan to keep the aid funds flowing. Prime Minister Pedro Passos Coelho inherits an economy that the European Commission forecasts will contract 2.2 percent this year and 1.8 percent in 2012 with a debt that will top 101 percent of GDP this year.

To contact the reporters responsible for this story: Sandrine Rastello in Washington at srastello@bloomberg.net; John Detrixhe at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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