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Small victory for the euro

Gavin Hewitt | 14:40 UK time, Wednesday, 12 January 2011

This day in Portugal had been signposted in advance as the first test for the euro this year. The country needed to raise funds by auctioning bonds.

Late last week every indication was that Lisbon would have to pay above 7%. One Portuguese official had said that borrowing costs like that were "unsustainable".

Brokers in Lisbon follow Wednesday's bond auction

Many saw the country teetering towards the bail-out emergency ward. Well, the worst didn't happen. In the event Portugal raised just over 1.25bn euros at a cost of 6.7%. That is still a very steep figure, but it provides the eurozone a small breathing space.

What it shows is that there are still buyers - many of them foreign - for the bonds of vulnerable eurozone countries. Enthusiasm may well have been boosted by pledges of support from Japan and China.

The reality for Portugal remains daunting, however. Yesterday the central bank in Lisbon predicted that the economy would contract by 1.3% this year. The austerity measures to reduce the deficit will likely have a "severe impact on the economy, tipping Portugal" into another recession. So the key question remains unanswered: how will Portugal find the growth to reduce its total debt?

There is a view in Lisbon that today's auction buys some time - perhaps until after the presidential election in a couple of weeks. "This is one hurdle that has been overcome, but it's not the end of the problems for Portugal and the eurozone, " said Ian Stannnard, an analyst at BNP Paribas.

One indication that the eurozone still expects further bail-outs came in comments from Olli Rehn, the EU's top monetary official. Referring to the main rescue facility, he said it might need to be "reinforced and the scope of its activities widened".

There was a similar line from the President of the European Commission, Jose Manuel Barroso. He urged member states to increase the size of the crisis fund, saying "it is perfectly possible to take these decisions no later than at the next European Council in February." The urgency, of course, has its roots in the fear that if a large country like Spain got into difficulty the existing fund may not be big enough to support it.

The German government quickly said that such actions made no sense at the moment. The French too are mindful of their voters and taxpayers. They believe the current 440bn euros in the fund are sufficient for the time being.

The German Chancellor, Angela Merkel, said today "the volume (of the fund) is far from being exhausted". "We will do what is necessary," she went on, "everything else will be discussed step by step".

Berlin and Paris understand the political sensitivities involved in expanding a rescue fund. They were eloquently summed up yesterday by Otmar Issing, a former chief economist at the European Central Bank. Bail-outs risk leading to a "transfer union". Highly indebted countries could be encouraged to blackmail more solid member states and that could raise political anger that eventually would undermine support for the single currency.

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