Moody’s Investors Service downgraded Portugal by four notches to 'Ba2' from 'Baa1' with a negative outlook yesterday.

The rating agency also warned of the “increasing probability” that Portugal would not be able to access the markets at sustainable rates for some time after 2013.   

“Such a scenario would necessitate further rounds of official financing and this may require the participation of existing investors in proportion to the size of their holdings of debt that will become due,” the rating agency added in a report.

The Portuguese downgrade to junk status comes amid Greece's struggles to avoid default. Last week, Greece finally got the approval on its  austerity package that cleared the way for a €8.7 billion ($12.5 billion) disbursement by the European Union that would go toward helping the country avoid default. The news, however, did little to rein in pricing and European paper continued to trade at wide levels.

"The initial relief over the votes in the Greek parliament accepting the austerity measures soon gave way to a realization that it does not mark the end of the euro-zone sovereign crisis, with risk markets bouncing on the news but range-bound thereafter," Royal Bank of Scotland analysts said. "For the most part, European asset-backed pricing has mirrored this broader market performance, with the most liquid bonds appreciating modestly off the Greek news."

Now with the news of Portugal augmenting worries, it is likely that the summer will continue to see market pricing on the widening trend.

Portugal downgrade will likely be followed by a similar action to Portuguese banks which would in effect hit covered bonds. According to analysts at Societe Generale the reappraisal of the country's covered bonds will not likely lead to the bonds being downgraded below investment grade but they will be close to the investment grade rating limit.

"The usual procedure at Moody’s is that once the downgrade of the sovereign is completed it takes a few days until the senior unsecured bank rating is affected as well," SocGen analysts said. "Moody’s argues that banks are supported by the government. If the latter weakens, this lowers its support capacity to banks. So banks should be downgraded too. And finally a lower bank rating leads to a lower covered bond rating."

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