March 9, 2016 / 9:13 AM / a year ago

Ratings and politics rattle Portuguese bonds as auction looms

* Lisbon sells bonds as rating worries weigh

* Portugal and Cyprus could face QE exclusion

* Portuguese president adds to political uncertainty

By John Geddie

LONDON, March 9 (Reuters) - Portuguese bond yields edged up on Wednesday with Lisbon selling new debt as investors weighed the prospect of more political uncertainty and a ratings slide that may force the country out of the European Central Bank's quantitative easing scheme.

Fitch shaved its rating outlook on Portugal from positive to stable, a move seen as raising the risk that DBRS -- which has the investment grade rating Lisbon needs to qualify for QE -- might downgrade it at the end of next month.

In a sign of what may come for Portugal, an ECB spokesperson said on Tuesday that junk-rated Cyprus may be excluded from QE because it is likely to exit its bailout programme at the end of March.

Countries must have an investment grade rating from one of the four agencies recognised by the ECB or be in a bailout programme in order to qualify for the 1.5 trillion euro bond-buying scheme.

The backstop of central bank bond buying has up until now helped reassure investors even though Portugal is governed by a fragile leftist coalition which has promised to roll back austerity imposed by their conservative predecessors.

Adding further uncertainty on the political front for Portugal, Wednesday sees the inauguration of a centre-right president who will assume powers next month that allow him to fire the government and call new elections.

"The political and fiscal situation in Portugal is more uncertain, which suggest keeping a cautious bias on PGB (Portuguese government bond) spreads in general," Societe Generale strategist Ciaran O'Hagan said.

Portugal's 10-year bonds rose 2 basis points to 3.03 percent on Wednesday, on track for their first week of rises in four, but still some way off two-year highs of 4.38 percent hit in February.

All other euro zone yields also edged up on Wednesday as investors turned cautious ahead of a European Central Bank meeting on Thursday that could disappoint high market hopes.

Lisbon will offer between 1 billion and 1.25 billion euros of 5- and 10-years bonds at an auction on Wednesday, while Germany also sells 4 billion euros of two-year bonds. Yields tend to rise ahead of bond sales as investors make room in their portfolios for the new supply.

Analysts said the ECB's QE was particularly important to Lisbon because the ECB buys a higher proportion of its debt than elsewhere in the bloc because purchases are based on each country's contribution to its capital and not outstanding debt.

"Portugal will be among the countries where PSPP (QE) buying as a share of 2016 gross issuance will be highest, so it will be important that DBRS will continue to keep Portugal at investment grade next month," ING strategist Martin van Vliet said. (Reporting by John Geddie; Editing by Toby Chopra)

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