Portugal faces rating cut, Spanish debt costs rise

Portugal was put on notice that its credit rating could be cut and fellow euro zone debtor Spain had to pay more to issue new debt, suggesting the currency bloc's crisis will rage unabated in 2011.

China, the world's new economic powerhouse, urged European policymakers to demonstrate as a matter of urgency that they can contain the euro zone's debt problems and pull the bloc around.

Ratings agency Moody's said it may cut Portugal's credit rating by one or two notches within three months, citing weak growth prospects as the government seeks to cut its debt, and climbing borrowing costs, although it said its solvency was not in question.

"The likely deterioration in debt affordability over the medium term and ongoing concerns about the economy's ability to withstand fiscal consolidation ... mean its outlook may no longer be consistent with an A1 rating," said Anthony Thomas, Moody's lead analyst for Portugal.

The cost of insuring Portuguese sovereign debt against default rose in response and the euro slipped.

Spain cleared its final debt sale of the year, but predictably had to pay a higher price and analysts warned of tough times ahead in 2011.

The yield on Spain's three month treasury-bill issue rose to 1.804 percent from 1.743 percent on November 23, while six-month paper cost 2.597 percent, up from 2.111 percent.

"All in all it's a reasonable result in current conditions, if far from impressive. It's going to be testing times for Spain, Portugal and even Italy heading into 2011," said Orlando Green, analyst at Credit Agricole.

Looking back to January this year, the Spanish Treasury paid just 0.38 percent on three-month paper, and 0.483 percent for six-month debt.

A pre-Christmas market lull has taken some of the heat off peripheral euro zone debt but the ratings agencies are flagging that the crisis will surely flare up again in 2011.

Already this month, Moody's has put Spain and Greece on review for possible downgrades and cut Ireland's rating by a savage five notches, while Standard & Poor's said it may cut Belgium's debt rating next year. Analysts said markets were pricing in even more doom for the euro zone's weaker members than the ratings agencies.

"Really the rating agencies are playing catch up with events and arguably they've got a long way to go to get back up to speed - they've been very much a lagging indicator throughout the crisis," said Chris Scicluna, deputy head of economic research at Daiwa Capital Markets.

The president of the European Council, Herman Van Rompuy, insisted the EU stood ready to do more if needed to ensure the stability of the euro zone area.

European Union leaders failed, at a summit last week, to agree any specific new measures to stop contagion spreading from Greece and Ireland, which have received EU/IMF bailouts, to other high-deficit countries such as Portugal and Spain.