Europe's debt market jitters flared up again Wednesday as investors worried about the near-term fates of Portugal and Ireland, an ill omen on the eve of a summit where EU leaders plan to complete their crisis-fighting plan.
Investors doubt the two countries, embroiled in financial crises that have created political shockwaves, will be able to cut their borrowing loads through austerity measures alone, meaning Europe's debt crisis will likely get worse before it gets better.
Portugal's prime minister quit late Wednesday after lawmakers failed to back his government's latest austerity package. The resignation puts Lisbon into political limbo just as it faces huge debt repayment deadlines and desperately needs markets' confidence to avoid a humiliating international bailout.
In Ireland, the results of stress tests next week will reveal the true extent of capital needs at the countries' struggling banks. Dublin wants more help to manage the bank losses, threatening to burn senior bondholders _ who have so far been spared in Europe's debt crisis _ if none is forthcoming.
At the same time, Prime Minister Enda Kenny's new government is not making many friends among its eurozone counterparts by continuing to refuse changes to its rock-bottom corporate tax rate even while demanding lower interest rates on its euro67.5 billion ($96 billion) bailout.
A German government and an EU official both said the chance of Ireland getting a better deal in its rescue loans at the summit was very low. Both officials declined to be named in line with department policy.
Against that backdrop, the mood in the bond markets was distinctly pessimistic.
The yield _ or interest rate _ on Portugal's ten-year bonds closed up 0.10 percentage point at 7.63 percent, just short of euro-era highs, while Ireland's yield ended 0.35 percentage point higher at 10.05 percent, after hitting a record earlier in the day.
More significantly, investors are asking for even more to lend in the short term. Analysts say that is due to concerns among private investors that they could be forced to take losses in case of bailouts under the eurozone's crisis regime for 2013 onwards.
Although EU officials have stressed that no debt issued before June 2013 would face a restructuring, markets are unnerved by the fact that the European Stability Mechanism, the new bailout fund, will get preferred creditor status. That means it will get repaid before any private creditors, making their investments more risky.
"Investors are now measurably more concerned about the short term outlook for Irish sovereign debt today than they were even during the height of the crisis in early November," said Simon Derrick, a senior analyst at The Bank of New York Mellon.
Though Portugal has not been bailed out yet, markets are acting like it's just a matter of time.
Prime Minister Jose Socrates said lawmakers' refusal to back his latest austerity measures made it impossible for him and his minority government to ensure Portugal's economic future. The package of spending cuts and tax increases was designed to cut the country's gaping budget deficit and had been lauded by the European Central Bank and other EU nations.
Socrates' resignation throws Portugal into a period of political uncertainty _ likely to last at least two months _ making it increasingly likely that the country will end up becoming the third euro state to be bailed out, following earlier rescues of Greece and Ireland.
Ireland's rates have surged even more than Portugal's this week amid speculation that premier Kenny will this week present new plans to force bondholders to take a share of the massive debts built up by Ireland's banks _ the main reason behind the Celtic Tiger's spectacular fall from grace.
If so-called senior bondholders are forced to take on their share of the Irish banking system's effective collapse, then banks in Germany, Britain and the United States _ the three biggest lenders to Irish banks _ could become the biggest losers.
Some analysts have argued that Ireland's tough rhetoric is merely a ruse to get the German and French governments to hand it a reduction in its bailout interest rates _ as they did for Greece at their last summit.
Most economists agree that the austerity efforts won't be nearly enough to help the country cover the cost of bailing out its banks. Economists estimate the Irish banks might need an additional euro35 billion ($50 billion) beyond the current euro50 billion ($71 billion) estimate.
In addition, the Irish banks are on financial life support from the Irish Central Bank and ECB, to the tune of over euro180 billion ($255 billion) in short-term loans.
Michael Somers, who was chief executive of Ireland's National Treasury Management Agency from 1990 to 2009, is skeptical of Ireland's ability to pay its bills. He says renegotiation of bondholder debt is inevitable.
"There's no way we'll ever pay this stuff back as far as I can see. It'll just be refinanced," Somers said. "The awful thing about it is, I know there are figures going round which show no growth for the next three years. And with the possibility of further tax rises and expenditure cuts, you wonder how actually we're going to get out of this mess. We're in a downward spiral."
The nerves are also showing in some of the eurozone's more fiscally sound states. A final decision on how to increase the region's existing bailout fund, the European Financial Stability Facility, to the promised euro440 billion may have to wait until after the summit, since Finland is blocking a deal, citing national elections in April, according to EU officials.
Brussels is bracing for large protests by Belgian unions unhappy with a deal struck earlier this month that threatens to limit wage increases and raise retirement ages across the eurozone.
Shawn Pogatchnik in Dublin and Barry Hatton in Lisbon contributed to this story. Pan Pylas contributed from London.