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Portugal bailout talk weighs on markets

By Pan Pylas

Associated Press

Published: Monday, Jan. 10 2011 9:48 a.m. MST

Cristina Povoa, a Portuguese broker, talks on the phone while working Monday, Jan. 10, 2011 in Lisbon. Europe's debt crisis looked increasingly likely to claim another victim on Monday, as Portugal's borrowing rates spiked to euro-era highs amid reports Germany and France are pushing it to accept outside help and prevent contagion to other countries.

Francisco Seco, Associated Press

LONDON — Europe's debt crisis and mildly disappointing U.S. jobs data weighed on stocks Monday, with reports claiming Portugal is under mounting pressure to accept an aid package to prevent contagion to other countries.

In Europe, the FTSE 100 index of leading British shares closed down 28.03 points, or 0.5 percent, at 5,956.30. Bigger losses were posted in the markets of euro countries, with Germany's DAX falling 90.78 points, or 1.3 percent, to 6,857.06 and the CAC-40 in France ending 63.55 points, or 1.6 percent, lower at 3,802.03.

The losses weren't just confined to Europe, though — on Wall Street, the Dow Jones industrial average was down 65.92 points, or 0.6 percent, at 11,608.84 around midday New York time, while the broader Standard & Poor's 500 index fell 5.56 points, or 0.4 percent, to 1,265.90.

"There is still an air of caution following the worse-than-expected U.S. employment numbers on Friday and... investors are mindful that the risk of another European sovereign debt crisis has not gone away," said Yusuf Heusen, a sales trader at IG Index.

Fears that Portugal was heading towards a bailout, like Greece and Ireland before, were acute in early trading in Europe. At one stage, the yield on Portugal's ten-year bonds rose nearly half a percentage point to 7.18 percent, before falling back to 6.94 percent on speculation that the European Central Bank was propping up Portugal's bond market — buying bonds helps lower the yield.

"According to market talk the ECB bought bonds issued by Portugal directly from banks this morning following a rocky start," said Andrew Wilkinson, senior market analyst at Interactive Brokers. "As usual the remedy worked and sent the bears into hibernation for now."

Despite the modest pullback, the cost Portugal is facing to service its debt is prohibitively high. Many think that even current rates are unsustainable in the medium-term and that the country will have to join Greece and Ireland in getting massive financial help from its partners in the European Union and the International Monetary Fund.

A test will be an auction of €1.25 billion in three year and nine year bonds on Wednesday and how much Portugal will have to pay to get investors to effectively lend it money. On Thursday, Spain and Italy are also scheduled to sell bonds and the big worry in Europe's capitals is that Spain, in particular, will be dragged into the mire.

Monday's market fluctuations follow a report in German newspaper Der Spiegel that France and Germany are pressing Portugal to tap a European rescue fund to keep the crisis from spreading to much-bigger Spain. Portugal denies it needs to do so but that doesn't mean it won't, if recent experience is anything to go by.

Analysts said there are distinct echoes of what went on with Ireland just a couple of months ago. Before Ireland was forced to accept a rescue from its partners in the European Union and the International Monetary Fund, there were numerous reports suggesting that Germany, in particular, was pressuring Dublin to take the funds to stop the crisis spreading. The Irish government also insisted it didn't need any help before eventually accepting a €67.5 billion bailout.

The prevailing view in the markets is that Europe will be able to rescue Portugal but that emergency support for Spain would test the limits of the existing bailout fund, potentially putting the euro project in jeopardy if governments don't put up more cash. Spain makes up around 10 percent of the eurozone economy, whereas Greece, Ireland and Portugal only account for around 2 percent each.

Against this backdrop, the euro is struggling though the fall in Portugal's ten-year yield provided the currency a measure of support— by late afternoon London time, it was trading up 0.2 percent on the day at $1.2939. However, the euro has been on the retreat so far in 2011 — it is down over 4 cents so far this year.

The debt crisis and how Europe's policymakers handle it will likely continue to be the main factor behind the currency's fortunes in the near-term, analysts said.

"The big hurdle for the euro is government bond auctions in Portugal and Spain with rising peripheral yields doing little to help market confidence at the moment," said Vassili Serebriakov, an analyst at Wells Fargo Bank.

Earlier in Asia, China's Shanghai Composite index fell 1.7 percent to 2,791.81, while Hong Kong's Hang Seng dropped 0.7 percent to 23,527.26. South Korea's benchmark Kospi fell 0.3 percent to 2,080.81.

Financial markets in Japan were closed Monday for a national holiday. The Nikkei 225 stock average, Asia's largest, rose Friday to a fresh eight-month high of 10,541.04.

Benchmark oil for February delivery was up $1.30 at $89.33 a barrel in electronic trading on the New York Mercantile Exchange.

AP Business Writer Kelly Olsen in Seoul contributed to this report.

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