Standard & Poor’s has cut Portugal’s credit rating by two notches, warning that the country’s political crisis heightened the risk that it would be unable to refinance its debt.

S&P's downgrade in Portugal’s long-term credit rating from A- to BBB is the lowest attributed by any rating agency, bringing Portugal’s credit standing closer to junk status.

S&P also warned that it could cut Lisbon’s rating by a further notch depending on the outcome of negotiations on the eurozone’s bail-out fund.

S&P’s decision on Thursday night came hours after Fitch Rating downgraded Portugal’s long-term rating by two notches from A+ to A- because of increased financing risks caused by the fall of the Socialist government.

S&P and Fitch have both placed Portugal’s ratings on negative outlook, implying further downgrades could be made in the near future.

Aníbal Cavaco Silva, Portugal’s president, is to meet political parties on Friday in effort to resolve the crisis triggered by the resignation of José Sócrates, the prime minister, after his defeat in a key vote on austerity measures.

Political leaders said the most likely outcome was an early election at the end of May or early June.

Eileen Zhang, an S&P credit analyst, said the political uncertainty caused by the collapse of the government could damage market confidence, pushing up financing costs and increasing the likelihood that Portugal would seek an international bail-out.

Interest rates on Portuguese government bonds of all maturities shot up on Thursday amid fears that the political void left by the prime minister’s resignation would make it difficult for the country to meet a total of €9.5bn in debt payments due in April and June.

Yields on 10-year Portuguese bonds on Friday rose 12 basis points in early trading on Friday to a new euro-era high of 7.78 per cent, a level investors and officials in Lisbon acknowledge is unsustainable.

Ms Zhang said that despite the rejection of European Commission-backed austerity measures by Portugal’s opposition parties, reduced investor appetite for Portuguese debt meant the next government would have no alternative but to adopt similar reforms.

European Union leaders meeting in Brussels on Thursday urged Portugal’s political parties to adopt new austerity measures and economic reforms as proof of their commitment to fiscal consolidation.

S&P forecast that the Portuguese economy would contract by 2 per cent this year, requiring the next government to implement “additional fiscal consolidation measures” to meet the country’s budget deficit targets.

The agency said the political crisis and expected election campaign could also stall economic reforms announced by the outgoing government in December, including plans for centralised wage bargaining.

If Portugal had to seek a bail-out from the EU and the International Monetary Fund before an early election, S&P said a caretaker government lacking a strong mandate could delay negotiations and the disbursement of rescue funds.

Financial Times