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With Portugal plea, Europe hopes crisis contained

By Pan Pylas

Associated Press

Published: Thursday, April 7 2011 8:20 a.m. MDT

A woman hands out free newspapers by the closed gate of a subway station at Lisbon's Cais do Sodre public transport hub during a subway workers strike Thursday, April 7, 2011. Portugal asked for a bailout Wednesday to relieve its crushing debt, joining Greece and Ireland by becoming the third eurozone nation to seek outside help amid a bruising financial crisis.

Francisco Seco, Associated Press

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LONDON — Portugal's request for a bailout could mark the moment that Europe finally contained its debt crisis.

Unlike previous bailout requests, Portugal's has not been greeted by a chorus of concern in financial markets over which country will be next. The European Central Bank even raised interest rates on Thursday as it turned its sights from the dangers of the debt crisis to the problem of inflation.

That suggests that after a year of summits, political spats and last-minute emergency measures, markets believe the bailout domino effect may be over — though analysts warn the crisis has seen false dawns before.

In part, the markets had already accounted for Portugal's troubles as its borrowing costs became more and more unsustainable, so the only surprise in the bailout request was its timing.

The announcement by Portugal's caretaker Prime Minister Jose Socrates on Wednesday evening capped a torrid few months for the country, which had been using every tool at its disposal to prevent an embarrassing bailout.

Its firefighting efforts were in vain. A combination of weak growth and high debt gave it no alternative but to cave in and tap Europe's rescue fund.

But whereas the bailouts of Greece and Ireland were immediately followed by an increase in market pressure on the next weak link in the eurozone, this time investors were not targeting another country, notably Spain.

"There is little to suggest that the Portuguese bailout, that has been imminent for some time now, will infect Spain," said Sony Kapoor, managing director of international economic think tank Re-Define. "Spain is by far a stronger and more dynamic economy."

The euro remained strong, near 15-month highs against the dollar at $1.43, largely thanks to expectations that the European Central Bank will follow up Thursday's interest rate increase with more hikes this year.

The response in bond and stock markets has been equally relaxed, with Spanish borrowing rates in the bond markets largely unchanged and its stock market one of the only in Europe to rise on Thursday.

Since the government debt crisis exploded over a year ago, Spain was bracketed in with Greece, Ireland and Portugal as an imperiled eurozone economy.

Fears that the debt crisis would inevitably end with Spain requesting a bailout raised all sorts of questions about Europe's future, not least whether the euro currency itself could survive such a larger, more expensive rescue mission. Those fears pushed the 17 euro countries into action, and they have largely thrashed out the details of a permanent bailout fund.

On the national level, Spain has moved to protect itself from speculative attacks in the bond markets. It has made concerted efforts — still insufficient, according to some analysts — to restructure its fragile banking sector, notably the savings banks, and to implement tough austerity measures. It has raised taxes, cut public sector wages and lifted the retirement age from 65 to 67.

If anything, these efforts have bought the country time to further persuade markets that it's on the right path to healing its public finances. Though its overall debt burden at around 65 percent of national income is lower than Portugal's 90 percent, Spain's annual borrowing is higher and investors will want to see evidence that the budget deficit is coming down. For 2011, the Spanish government has predicted it will reduce its budget deficit to 6 percent of gross domestic product from 2010's 9.2 percent.

"Given how the crisis has unfolded over the course of the last few years, we struggle to see that the activation of help for Portugal will mark the end of contagion," said Nick Matthews, senior European economist at the Royal Bank of Scotland. "We therefore remain of the view that countries with high private and sovereign debt will remain at the mercy of further loss in market confidence."

Even if the crisis has been contained for now, the eurozone will continue to suffer from the effects of the debt market turmoil.

Greece, Ireland and Portugal face years of hardship to get public finances back into shape, and many think they will have no option but to restructure their debts at some stage. That means they will have to get governments' creditors — mainly the big banks in Germany and France — to take losses.

The focus in the coming days will likely center on the size of the Portuguese financial package and what the cash-strapped country will have to do in return for the funds. Eurozone finance ministers are due to meet Friday in Budapest, Hungary, and Portugal's plight is clearly going to be the main topic of discussion.

Discussions over the package — most estimates in the markets are that Portugal will need about €80 billion ($114 billion) — will likely be complicated by the fact that Portugal doesn't have a government in place. Socrates resigned last month following a parliamentary defeat on additional austerity measures, and is now serving as caretaker leader.

Associated Press writers Barry Hatton in Lisbon, Portugal, and Daniel Woolls in Madrid contributed to this report.

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