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Portugal ousts government — but don't worry yet

The prime minister's been ousted and the country faces either further elections or an unstable left-wing coalition.

So, why aren't markets more worried about Portugal's future?


Patricia de Melo | AFP | Getty Images

They seemed to be at first — the yield on Portuguese 10-year bonds reached a -- albeit still very acceptable -- five-month high of 2.85 percent on Monday and the benchmark PSI 20 stock index tumbled in the four days to Tuesday.

But after the collapse of the center-right government on Tuesday, markets seemed little stirred by the possibility of a caretaker government and more elections, or the more likely prospect of a left-wing coalition with an anti-austerity agenda, led by the Portuguese Socialist Party.

The PSI 20 index ticked 0.6 percent higher and Portuguese 10-year bonds fell to yield 2.748 percent on Wednesday — suggesting waning fears about the state of play in the small euro zone nation. Bond prices in other "peripheral" euro zone countries also rose, with yields falling on Greek, Italian, Spanish and Irish debt.

"A populist political coalition looks set to derail Portugal's economic plans, but risks so far remain muted and isolated," Neil Mehta, Markit fixed income analyst, said in a report on Tuesday.

Five months ago, Greece's bailout standoff with international creditors caused ripples of alarm in markets. However, the uncompromising stance struck by European officials in dealing with Athens seems to have soothed fears of radical anti-austerity politicians proliferating across Europe.

"The euro zone's dynamic has changed after July's Greek crisis, when Syriza was met by EU hardliners. Any other populist uprisings may also be challenged by the same stiff opposition, which could be another reason signs of contagion are little," Mehta said.

Furthermore, the leader of the Portuguese Socialist Party, led by Antonio Costa, is a moderate and is unlikely to wish to completely derail the previous government's macroeconomic policies. Notably, he has already committed to taking Portugal out of the EU's "Excessive Deficit Procedure" by reducing the public deficit below 3 percent of gross domestic product (GDP) as soon as possible.

While it is unclear how this fits in with the proposals of Costa and his allies to roll back some of the former government's public sector wage cuts, as well as unfreeze pensions and reverse some privatizations, markets appear to have a relatively open mind.

"The markets await the content of the economic and fiscal plans of the new government in order to assess whether they square with its overall fiscal objectives," Antonio Garcia Pascual, chief European economist at Barclays, said in a report on Wednesday.

The ongoing economic recovery in Portugal may help. The country was hit hard by the euro zone debt crisis and received 78 billion euros ($84 billion) of aid from Europe and the International Monetary Fund between 2011 and 2014. However, its economy expanded in 2014 and is seen growing by a fairly healthy 1.7 percent this year — although its gross public debt remains very high at just under 130 percent of GDP.

Expectations of further bond-buying from the European Central Bank, which may be announced as soon as next month, have also helped bring euro zone yields down.

"Any market volatility created by Portugal's political situation should be contained, thanks to QE and to the presence of European monitoring. Moreover, Portugal is no longer in an extreme economic and financial situation and the cyclical recovery remains quite robust," Credit Suisse said in a report this week.

— By CNBC's Katy Barnato. Follow her on Twitter @KatyBarnato.