Portugal seeks bailout, Trichet confident rate hike will only help

The Portuguese government has requested assistance from the European Commission only hours before the European Central Bank (ECB) moved to raise interest rates, which it believes will help support the sovereign.

José Sócrates, Portugal's outgoing prime minister, on Wednesday said the Portuguese government had presented an application to the European Commission to apply for financial assistance in order to ensure financing conditions. Sócrates said the decision was "a last resort" after the country's parliament rejected a series of proposed austerity measures. On March 11, Sócrates dissolved his government and announced his resignation after budgetary cuts to reduce the country's fiscal deficit to 4.6% of gross domestic product (GDP) by 2011 failed to receive the support of parliament.

The request for a bailout from Portugal did not deter the ECB from raising rates. On Thursday the eurozone central bank raised its benchmark interest rate by 25 basis points to 1.25%. At a conference in Frankfurt, Jean-Claude Trichet, the president of the ECB, dismissed reporters' fears the rate hike would destabilise the peripheral countries, instead arguing that the move would reinvigorate confidence in their respective economies. Trichet also dismissed suggestions that raising interest rates would translate into higher borrowing costs for sovereigns pointing instead towards the lower yields well-anchored inflation expectations would bring.

As of 2010, Portugal's deficit was 8.6% of GDP, whilethe country's debt-to-GDP ratio was 92.6%. A number of rating agencies downgraded Portugal's credit rating, including Moody's, which on Tuesday said it was "a matter of urgency" the government approach the European Financial Stability Facility (EFSF).

Silvio Peruzzo, a senior strategist at Royal Bank of Scotland, said Portugal's decision to delay its request could have negative consequences on market confidence. "The surprise for market participants has probably been why it took so long for Portugal to request the help. This is a very important point as it highlights a key weakness of the current help mechanisms whereby the negative stigma and cost attached to the help mechanisms are such that they typically lead to a fall of the government and to political instability," Peruzzo said.

"On the economy side, the help leads to a further increase in contingent sovereign debt and thus to a further deterioration in market sentiment as this is actually seen as increasing the risk of default rather than reducing it," he said.

Jonathan Loynes, the chief European economist at Capital Economics, said markets' attention could now move on to bigger economies like Spain. "While it has lower public debt and a smaller current account deficit than Portugal, it has a bigger budget deficit, weaker growth and much higher unemployment," he said.

Loynes said that although the probability of Spain defaulting had recently fallen as a result of actions taken to restructure its banks and its fiscal consolidations efforts, Spain may still struggle to keep out of the crisis.