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Portugal, Spain become market target after Ireland

Europe's efforts to contain its debt crisis came under increasing strain Tuesday as bond market jitters spilled into Portugal and Spain, seen as the 16-nation eurozone's next weakest links now that Ireland has followed Greece by accepting a massive international rescue.

The Iberian countries' borrowing costs rose, suggesting investors are more worried about default, while Spain limited the size of a bond sale because traders demanded sharply higher premiums. Portugal's benchmark PIS stock index slumped 1.5 percent and Spain's IBEX was down 2.3 percent.

Spooked by the scale of Greece's bailout requirements in May and Ireland's banking failures, international investors are taking a closer look at the public finances of eurozone countries and they don't like what they're seeing, particularly in Portugal.

Traders are "looking for their next target" and Portugal fits the bill, said Emilie Gay, an analyst at Capital Economics in London. She predicts Portugal will have to ask for help by early next year, when it has to begin refinancing billions of euros (dollars) in government bonds. A bailout for Portugal would cost at least €50 billion, according to Capital Economics.

Portugal accounts for less than 2 percent of the eurozone's total economy but a potential bailout would crank up pressure on Spain, the European Union's fourth-largest economy, and entail possibly dramatic repercussions for the entire bloc.

Analysts at Capital Economics described the risk of a Spanish bailout as "fairly low" but warned that "the cost would be devastatingly high."

"This threat is therefore closely linked to the risk of some form of eurozone breakup, stemming either from Spain being forced to leave and default or perhaps even from Germany jumping ship," the analysts said in a report to investors Tuesday.

Ireland's decision to accept a loan to prop up its banks, which may reach €100 billion ($136 billion), and make sharp budget cuts has come just six months after the EU and IMF provided a similar sum for Greece.

Greece, meanwhile, is still grappling with its promised reforms and must make an extra effort to meet next year's deficit targets, its international donors said Tuesday.

The establishment of a €750 billion ($1.05 trillion) safety net, following Greece's bailout, for any other eurozone members facing the risk of imminent loan defaults has done little to quell market fears.

Portugal's recent public finances figures have sharpened concerns' about the government's ability to handle its debt load. Official data this week showed public spending rose 2.8 percent in the first 10 months of this year compared with the same period a year earlier. Crucially, higher interest payments on its loans outweighed an increase in tax revenue, suggesting the weight of existing debt is unsustainable as it offsets any progress in public finances.

Even before Ireland accepted a bailout, Portugal was already considered a risk because of its meager economic growth and high debt. It has borrowed huge amounts to finance sacred welfare entitlements and private spending — while protecting jobs through outdated labor laws that make it difficult to hire and fire workers. Its industry has also broadly failed to move with the times.

Spain, though much larger than Portugal, is also feeling the heat of the market spotlight. Its borrowing costs soared Tuesday in a sale of 3- and 6-month bills and the government declined to sell as much of the debt as initially planned because of the higher rate.

The central bank says the treasury was obliged to pay 1.7 percent in average interest to sell €2.1 billion ($2.87 billion) in 3-month bills, nearly double the 0.95 percent rate paid in the last such auction Oct. 26. The rate for the sale of €1.2 billion in 6-month bills jumped to 2.1 percent from 1.3 percent in October.

Spanish Central Bank governor Miguel Angel Fernandez Ordonez said the effects of the Irish crisis had "spread rapidly to periphery" countries.

He said Spain needed to "remain vigilant," adding that the government's fiscal consolidation program "is not without risks" and warning the government against straying off course.

Spain is struggling to emerge from nearly two years of recession. Third-quarter growth was flat, after two quarters of timid expansion and unemployment is at a eurozone high of 19.8 percent.

The government has enforced austerity measures including a freeze on pensions and a cut in civil service wages by an average of five percent.

The 2011 budget foresees cutting the deficit from an expected 9.3 percent of GDP this year to 6.0 percent in 2011. Last year it stood at 11.2 percent of GDP.

Portugal, which last year had the fourth-highest deficit in the eurozone after Greece, Ireland and Spain, is also readying an austerity package, featuring tax hikes and pay cuts, for introduction Jan. 1. Parliament is due to approve the measures on Friday.

However Portugal, like other European countries such as France, is facing a popular backlash against its austerity program. A national 24-hour strike Wednesday is expected to bring the biggest shutdown in public services in more than 20 years.

Portugal faces a massive struggle to restore market faith in its economy. It needs further reforms of the labor market to increase its competitiveness, but unions are likely to balk at any proposal that envisages a streamlining of staffing levels.

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Alan Clendenning and Ciaran Giles contributed from Madrid, Elena Becatoros from Athens, and Shawn Pogatchnik from Dublin.