Lisbon’s borrowing costs appear set to rise: economist
Portuguese government bond prices have been under pressure, sending yields higher, on worries the country’s sovereign debt could soon lose its last remaining investment-grade rating.
The rise in the government’s borrowing costs reflect fears that such a downgrade would render the European Central Bank unable to purchase Portuguese government debt as part of its asset-buying program. It would also mean that Portuguese banks wouldn’t be able to pledge Portuguese government bonds as collateral in return for cheap loans from the ECB.
See: 5 things to watch for at Thursday’s key ECB meeting.
Borrowing costs did fall back from their February highs after ECB officials indicated they would work to make sure any further cuts to the central bank’s deposit rate, which is already in negative territory, would be structured to protect banks. That was important because Portugal’s banking sector, along with Italy’s, is seen among the region’s most vulnerable. Negative rates can be a burden for banks, who have to pay central banks to hold on to a portion of their excess reserves.
But Portuguese yields are still elevated relative to their peers on the eurozone’s so-called periphery (see chart below). And if DBRS—the only major ratings firm to still rate Portugal as investment grade—cuts its rating next month, things could get ugly, notes Jennifer McKeown, senior European economist at Capital Economics, in a Tuesday note.
Portugal’s new left-leaning government has run afoul of the ratings firms, who have expressed doubts over the country’s budget path.
McKeown notes that a junk rating need not necessarily render Portuguese debt ineligible for purchase by the ECB or for use as collateral. After all, the central bank has granted “waivers” before, allowing it to accept debt rated as junk for collateral in Greece, for example. And the ECB could also move to widen the range of assets it buys, which means it could purchase other Portuguese assets that would allow it to support the country’s economy.
But, as McKeown reminds, waivers can only be granted to countries that are participating in a bailout program and complying with its terms. Portugal exited its bailout program in 2014.
She also notes that the ECB suspended Greece’s waiver last February as the battle between Greece’s radical Syriza government and European authorities heated up. There’s little reason to expect the ECB to show Portugal greater sympathy, McKeown said.
In part that’s because earlier purchases of Portuguese government debt under the defunct Securities Markets Program left the ECB holding nearly a third of Portuguese bonds—close to the central bank’s limit. That in itself could offer the bank a convenient excuse to stop buying Portuguese bonds just before the limit is reached.
And even if the ECB does go for buying more private-sector debt, that might not be of much help to the Portuguese, who appear to have few of the very highly-rated assets that would likely be part of the mix, she said.
If the ECB shuts Portuguese debt out of its bond-buying mix—something that the economist sees as likely if DBRS downgrades—it’s likely to cause investors to become more worried about the prospect of default. The result would almost certainly be a further jump in bond yields, possibly even toward the 8% level that forced Portugal into a bailout in 2011, McKeown said.