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Portugal crisis deepens, ECB hinders Irish bank plan

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Portugal's budget deficit ballooned above target last year and a disagreement at the European Central Bank threatened to undermine Ireland's plans for finally resolving its bank crisis.

Revised figures published today showed Portugal's deficit was more than a percentage point above target at 8.6 percent of GDP, bringing the overall debt burden that Lisbon is struggling to finance to 92.4 percent of its annual output.

Bond markets, which have been pressing the country for months to seek EU and IMF support, responded by pushing yields on its bonds to new euro-era highs and debt agency plans cast a note of doubt over issuance in weeks ahead.

The resignation of Prime Minister Jose Socrates after parliament rejected a new round of budget cutbacks last week has left Portugal in limbo, with only a caretaker administration that would find it hard to commit to a near-term rescue.

"These (revisions) are very much one-off factors and don't have a bearing on the deficit for next year," said James Nixon, European economist at Societe Generale.

"That doesn't mean to say there shouldn't be a funeral march for Portugal, funding is untenable given where yields are."

Europe's debt crisis has spread to its banks, which are being forced by rating agency downgrades into the arms of the European Central Bank - the lender of last resort -as credit markets shut their doors to them.

Ireland is hoping to persuade investors it finally has control of its financial crisis Thursday when it announces the ultimate bill for bullet-proofing its banks and overhauling the sector.

But vital support from the ECB may not be immediately forthcoming and that could undermine Dublin's plan.

Euro zone official sources told Reuters Thursday that there had been internal disagreements within the ECB's Governing Council over plans for a new liquidity facility and that an announcement of the facility would not be made today as expected.

The ECB is struggling to come up with a solution to how it reins in the emergency support it has given to money markets since the financial crisis hit in 2008, without paralyzing some of those banks.

COMING POLLS

With President Anibal Cavaco Silva likely to decide on a date for elections today, the leader of Portugal's opposition has pointed to the option of a bridging loan to tide it over until a new government is in place.

The higher deficit - due to losses at a nationalized bank and public transport companies - comes as the government faces paying back 9 billion euros in maturing bonds in April and June.

The minority Socialist government had said earlier this year that the deficit would actually beat the 2010 target.

"The government is not irresponsible and will guarantee that there is the necessary financing so the country can live up to its responsibilities and honour commitments to its creditors," Finance Minister Teixeira dos Santos insisted Thursday.

But the state bond agency in its plans for the second quarter admitted that any bond issuance would be subject to market conditions - a reference it has not made previously that suggests the doubt about finding buyers at feasible prices.

Portuguese 10-year yields climbed above 8.5 percent with 5-year yields at 9.3 percent and the spread over Bunds above 500 basis points.

STRESS

The new government has also threatened to impose losses on senior bondholders in Irish banks not covered by a state guarantee, but the signs were that it may have to settle for appealing for broader European action on the issue.

As ratings agencies have acknowledged this week, investors are increasingly convinced that Europe is moving toward a broader sharing out of the costs of a debt crisis that dates back to the 2008 banking turmoil.

The new European fund for bailing out countries after 2013 is expected to provide a mechanism for that to happen.

As such, one question over the stress tests is whether they provide for all the losses banks are likely to suffer as creditors of struggling states.

"It (the tests) can't draw a line under the problems, because the problems are broader, there are funding issues which are related to all the peripheral countries," said Mike Aynsley, chief executive for the now state-controlled Anglo Irish Bank.

"What I hope is this will draw a line under the uncertainty and increase confidence in bank balance sheets and specify a robust level of capital requirement. That's a good start."

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