June 3, 2014 / 8:38 AM / 3 years ago

Portugal yields rise as Lisbon says austerity ruling to hit budget

LONDON, June 3 (Reuters) - Portuguese bond yields rose to a one-week high on Tuesday after Lisbon said the rejection by the country's supreme court of some austerity measures will have a "significant" budget impact.

Finance Minister Maria Luis Albuquerque said Friday's ruling, which will create a fiscal gap of about 700 million euros this year, could complicate Portugal's formal exit from its international bailout, which ended last month.

The austerity measures struck down by the court were imposed under the 78 billion euro rescue programme, a final review of which has still be signed off by the European Union and IMF.

Albuquerque said the court decision would mean a letter of intent sent to the creditors to mark the end of Portugal's bailout would have to be changed.

Portuguese 10-year yields rose 2 basis points to 3.70 percent, extending Monday's rise and underperforming the rest of the market, which was broadly underpinned by expectations of monetary stimulus from the European Central Bank this week.

"Portugal will need to fix this as soon as possible and find alternative measures (to plug the budget gap) as there's a risk we could have widening spreads and a deterioration in its ratings outlook," said ING strategist Alessandro Giansanti.

Portugal needs to sharply cut its budget deficit in coming years under European Union rules. It has been forced to review its finances a number of times in the past years following interventions from its top court.

Credit Agricole strategists said this week's underperformance by Portuguese bonds presented a buying opportunity.

"The court has nixed government spending cuts four times before and, while this has tended to alter the balance between revenue and expenditure adjustments somewhat, the bottom line is that fiscal retrenchment has continued at an appreciable pace," they said in a note.

Other peripheral bonds were firmer ahead of preliminary euro zone May inflation data expected to cement the case for monetary policy easing from the ECB later this week.

Several banks, including RBS and Barclays have revised their forecasts downwards to 0.5 percent after German annual inflation slowed to its weakest in year in May. A Reuters poll forecast euro zone year-on-year inflation to remain flat at 0.7 percent.

Spanish 10-year yields were 2 bps down at 2.83 percent , with Italian equivalents 1 bp lower at 2.96 percent. (Editing by Catherine Evans)

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