LONDON: Portuguese government bond yields reversed early rises on Wednesday as the prospect of additional stimulus from the European Central Bank trumped concerns over political uncertainty in Lisbon.
Left-wing parties ousted Portugal's ruling centre-right on Tuesday, the first such move against an elected government since 1974, paving the way for a Socialist-led administration to end years of austerity.
Benchmark 10-year yields in Portugal rose more than 5 basis points in early trade before reversing track to trade 1.6 bps lower at 2.78 percent. Portuguese yields have risen more than 45 bps since inconclusive election results on Oct. 4 led to a power struggle between the centre-right government and left-wing parties. Analysts said political risk was largely priced into Portuguese bonds although the market remained vulnerable.
They added that the prospect of further monetary stimulus from the ECB as early as December also provided strong support for bonds.
"The first reaction today has been to sell Portuguese bonds on political concerns and now markets will scrutinise the coalition that will take power and maybe there will be a more balanced judgment on whether there will be a departure from previous policy," Sergio Capaldi, a fixed income strategist at Intesa SanPaolo, said.
Some analysts said the political upheaval in Portugal had raised the risk of a ratings downgrade from Canadian ratings agency DBRS on Friday, which would deprive Lisbon of its last investment grade rating and leave its debt ineligible for purchase under the ECB's asset-purchase scheme.
In order to qualify for the scheme, the ECB demands that either Moody's, Standard & Poor's, Fitch or DBRS rate a country at investment grade, or that a country is compliant with a bailout.
DBRS is the only one currently rating Portugal at investment grade.
DBRS's lead analyst for Portugal told Reuters on Tuesday it would be concerned if commitment to fiscal adjustment were undermined, but would also consider recent political developments in its review.
ING's head of investment grade debt strategy, Padhraic Garvey, said nonetheless that the ECB's asset purchase programme would support Portuguese bonds.
Growing talk of a further cut to the ECB's deposit rate next month pushed the yield on Germany's two-year bond yield down 1 bps to -0.355 percent, matching a record low hit two weeks ago.
In another sign that expectations of further monetary stimulus are underpinning short-dated euro zone bonds, the yield on Italy's 12-month bill came in below zero at an auction on Wednesday for the first time.
Germany sold 2.5 billion euros of five-year debt at an average yield of -0.08 percent, down from -0.03 percent at an auction a month ago.
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