Looming rate hike to hit Portugal at its weakest

AP News
Posted: Mar 04, 2011 9:11 AM
Looming rate hike to hit Portugal at its weakest

The shock warning that European interest rates could rise as soon as next month has set alarm bells ringing in Portugal, slapping the debt-ridden country with an extra burden just as it fights for its financial future.

Though the prospect of higher interest rates by the European Central Bank doesn't immediately make Portugal more likely to tap a bailout, analysts warned Friday that rising borrowing costs will make the country's expected slide back into recession this year longer and more painful.

Mortgage rates would rise, business loans would become more expensive, and exporters would have a tougher time if the euro's value keeps rising.

That would be manageable in countries like Germany or France, but it is a grim prospect for Portugal, where unemployment is above 11 percent and households are buckling under the strain of tax hikes and pay cuts as the government struggles to heal its weak finances.

"It's definitely bad news for Portugal and the Portuguese," said Joao Pereira Leite, head of investments at Portugal's Banco Carregosa. "It would be, indirectly, another austerity measure."

The markets have moved in to price an interest rate increase from the European Central Bank next month after its President Jean-Claude Trichet indicated Thursday that a rate hike in April is "possible" though "not certain."

The ECB is increasingly worried about high inflation. Analysts note that because its remit is to control price increases, the ECB seems to be passing the burden of helping weak countries like Portugal onto EU governments and their bailout funds.

Trichet's comments prompted a sizable rally in the euro as the markets had not been positioned for a rate hike so soon _ in fact, the expectation was that rates would remain on hold until the tail-end of the year.

As one of 17 euro countries, Portugal saw its market borrowing rates rise to about 7.50 percent, near euro-era highs, as investors demand higher returns for lending to a country deemed a risky bet. Most analysts say anything above 7 percent is unsustainable in the longer term.

However, the now widely-anticipated April rate rise doesn't actually give the Portuguese government any greater incentive to tap Europe's rescue funds as the interest rate charged by the so-called European Financial Stability Facility is tied to the market rates.

"I don't think the events of the last day or two has increased the chances that they're going to immediately request a bailout, but higher rates are likely to be bad news for Portugal," said Ben May, European economist at Capital Economics.

As well as increasing borrowing costs for homeowners, businesses and the government, higher interest rates are likely to boost the euro against other currencies _ that's bad news for Portugal, whose exports are supposed to be a pillar of future growth prospects.

Portugal's consumer association DECO said higher mortgage payments would place already cash-strapped families under severe strain and predicted "tough times" ahead.

In contrast to most of its peers in the eurozone _ apart from bailout recipient Greece _ Portugal is expected to fall back into recession this year at a time when unemployment is at a record 11.2 percent and the government has to find funds to pay off bond market investors.

An April repayment of euro4.5 billion ($6.3 billion) is looming large. Portugal hasn't had difficulty raising funds on markets so far, and says the repayments are covered, but the level of its borrowing costs is key.