LONDON: Portugal's borrowing costs pulled away from one-month highs on Thursday after an agreement on the recapitalisation of ailing state-owned bank CGD eased worries about the health of the country's banking sector.
The European Commission and Portugal on Wednesday agreed in principle to the recapitalisation, on market terms, of Caixa Geral de Depositos, envisaging an injection of up to 2.7 billion euros ($3 billion) in state funds and nearly as much in debt and equity.
The news bought some relief to the Portuguese bond market. Yields last week suffered the biggest weekly jump in almost four months after DBRS, the ratings agency that holds Portugal's only investment grade rank, said pressures were building on the country's creditworthiness.
The country needs the current DBRS rating to qualify for the European Central Bank's bond-buying scheme.
While there were worries about what the injection of funds into CGD means for Portugal's already high budget deficit, investors focused on stability in the banking sector for now.
Portugal's 10-year bond yield, which fell five basis points on Wednesday, dipped to 2.98 percent in early trading on Thursday and closed flat at 2.99 percent. It is down about 10 bps from a one-month high hit earlier in the week.
"The recapitalisation of CGD is likely to have implications for Portugal's budget, but all in all it is positive," said DZ Bank strategist Daniel Lenz.
"It's better to have a stable banking sector." Portugal is still reeling from two bank rescues in 2014 and 2015 that undermined investor confidence.
CGD, its largest bank by assets, needs to bolster its capital because of high levels of bad loans on its books.
The government has been negotiating with Brussels for months so that any injection is not considered state aid and does not count towards the budget deficit, which Lisbon has promised to cut to 2.5 percent of GDP in 2016 from last year's 4.5 percent.
"It possible that this deal allows Portugal to draw a line under its banking sector ills even though that has implications for the debt profile," said Richard McGuire, head of rates strategy at Rabobank.
Analysts at Societe Generale noted fears that the recapitalisation could be financed through issuance of government bonds and said they would be disappointed if government issuance turns out to be heavier in time.
And with concerns about Portugal's DBRS credit rating expected to linger ahead of the agency's next review in October, any pull-back in bond yields was expected to be limited.
The broader euro zone bond market was largely steady with many investors sidelined ahead of a speech by Federal Reserve Chair Janet Yellen at a global central bankers' meeting in Jackson Hole, Wyoming, on Friday.
Germany's Ifo survey meanwhile showed business morale deteriorated sharply in August, posting the steepest monthly drop since the height of the euro zone debt crisis in 2012, as the Brexit shock weighed on sentiment among executives.
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