Eurozone leaders are meeting this weekend in a prelude to the main EU summit in a fortnight’s time, where they will attempt to work towards an expanded bailout fund to deal with the region’s debt problems. As ever, the market expects little progress.
Addressing the key issue, it’s less a question of whether Portugal will need to accept a bailout and more of a question of when. The likelihood is that this will be sooner rather than later as the longer Portugal delays the inevitable, the more expensive it will become. The ailing country’s 10-year bond yields reached euro-era highs yesterday at 7.55%, which is simply not sustainable. Portugal opposes turning to the EU and IMF for help, but similar bond yield trends triggered bailouts for Greece and Ireland last year, and if Portugal sticks to its stubborn line then monetary assistance may be forced upon it by April.
As if things weren’t bad enough for poor old Portugal, Trichet has recently indicated that the ECB will raise interest rates to fight inflation (as discussed in the last blog), which will only increase borrowing costs for a country that remains in recession. So, what choice does Portugal have?
Interestingly, the market has moved the spotlight back onto Greece this week, in light of Greece’s recent credit downgrade. However, the markets are fickle and the Portuguese problem will be back in the headlines before long.
The impact that a Portuguese bailout or a Greek default will have on the euro is not as clear as might be imagined. A trend appears to have emerged of fading market sensitivity to eurozone debt crises over the past year; Greece shocked investors, Ireland less so, and more recently the euro has strengthened across the board despite these imminent periphery issues. On the other hand, investors may lose patience with the eurozone’s inability to find a long-term solution. Clearly a firm agreement on the bailout fund at the end of this month would do much to set investors minds at ease.
For the time being, the single currency seems set to continue to benefit from its new “front-of-the-queue” status with regard to raising interest rates. However, once this arrives (consensus is that this will be in April), focus will then shift to the effect that this rate rise could have on countries like Portugal, and their impending funding issues. Accordingly, a long-term euro uptrend is far less secure than its monthly outlook and sterling could yet revisit the winning ways it enjoyed early this year, especially following its own rate hike (potentially May/June), which is bound to entice investors.
Richard Driver
Analyst – Caxton FX
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