Threat of Portuguese government collapse causes FTSE to fall 74 points and German Dax and French CAC to drop 1.5%
Stock markets were spooked by Portugal's descent into political chaos on Wednesday as the threat of a government collapse sent the country's borrowing costs into critical territory and threatened a new phase in the eurozone crisis.
The FTSE fell 74 points, or 1.2%, while the German Dax and French CAC tumbled 1.5% as markets digested rumours that the resignation of Portugal's finance minister and foreign minister could be followed by more colleagues. Market unease over the health of the world economy was exacerbated by the political drama unfolding in Egypt and a weakening in China's growth.
The Portuguese ministers quit the coalition government this week in a row over the ruling party's handling of the country's economic plight, amid fears that they will be followed by two ministerial colleagues who are members of the junior coalition partner. If that happened, observers fear that they could take down the centre-right government. However, the junior coalition party, CDS-PP, said this evening that there would be no more ministerial resignations.
European commission president José Manuel Barroso, a former Portuguese premier, said the indebted nation risked damaging its hard-earned financial credibility after two years of closely following its €78bn (£66.4bn) bailout programme, co-ordinated by the International Monetary Fund, European Union and European Central Bank.
"This delicate situation requires a great sense of responsibility from all political forces and leaders," he said.
The government's future hung in the balance after president Aníbal Cavaco Silva's office said he would meet the leader of the main opposition Socialists and other parties to discuss the deepening schism in the coalition. Under the constitution, he has the power to dissolve parliament and can invite opposition parties to form a government.
Speaking in Berlin, where he was attending the EU summit on youth unemployment, prime minister Pedro Passos Coelho reiterated that he had no plans to resign. He said: "I am confident that we will be able to surpass this difficulty … I hope this internal crisis can be overcome very quickly."
With no solution imminent, the euro fell and the interest rate on Portuguese government debt soared past the 7% level – where debts are considered unsustainable – to hit 8.1% at on point, before settling back at 7.5%. The PSI 20 stock index in Lisbon fell by 5%, led by sharp losses of over 10% in bank shares
Only last month the IMF said Portugal's ability to meet the terms of a 2011 rescue package was "fragile" and the coalition was finding it difficult pushing through spending cuts and labour market reforms.
In recent months the IMF has appeared at odds with its bailout partners, preferring to take a more lenient stance than Brussels and the ECB.
However, the German government, which is the largest lender under the bailout terms, has forced the trioka to maintain a hard line. Portugal appeared to be on track to meet its obligations and had hoped to return to the international money markets next year to fund its debts, but without a lower interest rate on its debt or a longer payback timetable, that prospect looks under threat.
Jan Randolph, director of sovereign risk at IHS Global Insight, said Portugal had won strong support in Berlin for its efforts, but it could only expect further bailout funds if it maintained the pace of reform. He said the situation in the eurozone remained difficult while Spain and Italy struggled to grapple with economic and labour market reforms.
Bank of America Merrill Lynch analysts said the combination of surging yields and political uncertainty "reduces the prospects of Portugal regaining full market access in the next year", leading to expectations of a new bailout being required.
That, in turn, could send Portuguese bond yields even higher as a second bailout could involve Greece-style losses forced upon debt holders, the analysts said.
Meanwhile, a report showing slowing growth in China's service sector also weighed on markets. The National Bureau of Statistics reported that China's services PMI, a measure of activity, had fallen to a nine-month low of 53.9 in June from May's 54.3.
Oil prices recovered some of the lost ground on Wednesday following fears that turmoil in Egypt will undermine stability in the Middle East and hold up supplies. In the US, the Dow Jones Index closed up 0.4% as investors digested stronger-than-expected private sector jobs data.
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