War in the Middle East doubles Portugal’s short-term debt risk premium

European sovereign debt markets experienced high tension last week after the US and Israel attacked Iran. Oil prices soared to highs not seen since the Covid-19 pandemic, Treasury bond rates rose worldwide, and what had been a steady decline in European Central Bank (ECB) interest rates turned, in a matter of days, into expectations of a rise.

For Portugal, the week left a particular mark: not only did the yield curve show a generalised and significant rise in the yield on Treasury Bills and Bonds, but it also recorded the largest percentage jump in the short-term risk premium in the entire Eurozone, with the spread on 2-year Treasury bonds against Germany — the extra interest that investors demand to finance Portugal rather than Berlin — more than doubling in just five days.

Between 27 February and last Friday, 6 March, this premium jumped from 3.6 basis points to 8 basis points, a variation of 119%, the largest of all Eurozone countries, according to data compiled by ECO. This means that the relative cost of Portugal borrowing in the short term from investors has increased significantly compared to its main benchmark.

For comparison purposes, the yield spread between Spanish 2-year bonds and their German counterparts increased by 44.1%, Ireland’s by 42.9% and Greece’s by 29.2%, while countries such as Belgium, Austria and Croatia even saw their risk differential with Germany narrow during the week.

This abrupt movement in short-term bonds has a precise technical explanation that should not be confused with a deterioration in Portuguese public finances.

“The yields on 2-year Treasury bonds mainly reflect short-term inflation expectations and, consequently, the evolution of the ECB’s monetary policy, i.e., they reflect more the interest rate risk”, explains Paulo Monteiro Rosa, senior economist at Banco Carregosa.

What is at stake is an almost instantaneous reassessment of expectations regarding the European Central Bank’s interest rates. The closure of the Strait of Hormuz — a vital corridor for oil transport from the Middle East — caused crude oil prices to skyrocket, with Brent accumulating gains of around 28% in the week to over $93 per barrel.

An energy shock of this magnitude threatens to reignite inflation in Europe, forcing the institution led by Christine Lagarde to extend its planned rate cuts or even reverse course. In practice, the money markets are now pricing in, with complete certainty, at least a 25 basis point rise in ECB rates by September, a radical reversal from the previous week, when the scenario of cuts still dominated.

“With the outbreak of the conflict and the rise in energy risks, investors began to discount the possibility of an inflationary shock, resulting in an upward revision of expectations for ECB interest rates. This adjustment was reflected more immediately in short-term yields and, consequently, in the spread against Bunds”, Paulo Monteiro Rosa told ECO.

In the specific case of Portugal, the percentage jump in the two-year spread is also amplified by specific reasons. “Movements of this magnitude result not only from the revision of expectations for ECB interest rates, but also from technical market factors, such as the lower liquidity of Portuguese securities”, contextualises the Banco Carregosa economist.

For António Nogueira Leite, former director of Caixa Geral de Depósitos and professor at Nova SBE, the rise in the risk premium on two-year Treasury bonds reveals “the possibility of a greater impact on prices and public accounts in the short term”.

As for the actual trajectory of interest rates, the economist is cautious. “I would interpret this development as indicating an expectation of a rise in key rates if the conflict and its effects persist”. However, António Nogueira Leite believes that this is unlikely to happen before the end of spring, “if it happens at all. This is not certain, but depends on military variables and the strategy of the parties in conflict”.

Portugal becomes riskier and IGCP comes under pressure

In the long term, the impact was also felt, albeit in a more restrained manner. The spread between 10-year Treasury bonds and 10-year German Bunds widened from 35.8 to 44 basis points, an increase of 20.2%, the sixth largest increase in the Eurozone.

With this movement, Portugal dropped one position in the long-term risk ranking, being overtaken by Croatia, whose spread narrowed by 22% during the week. Portugal thus moved from sixth to seventh least risky country in the Eurozone for ten-year financing.

In the short term, the decline was more significant: Portugal ceased to be the third safest country for lending money at 2 years — a position it shared almost exclusively with the Netherlands and Germany — to fall to sixth place in the ranking. Still, these figures need to be put into context.

• Despite all the turbulence, Portugal remains one of the Eurozone countries with the lowest risk premium compared to Germany, both at 2 and 10 years.
• In addition, Portuguese bonds continue to rank among the sovereign bonds with the lowest yields among their eurozone peers, with the yield on 10-year Treasury bonds closing the week at 3.3% and the yield on 2-year bonds at 2.39%.

“The sharper rise in 2-year yields suggests that the market has begun to incorporate expectations of a more restrictive monetary policy in the short term. In just a few days, expectations have shifted from a scenario of slight rate cuts in 2026 to one pointing to a rise of around 25 basis points in ECB rates”, summarises Paulo Monteiro Rosa, adding that “so far, there are no signs of a material deterioration in Portuguese debt financing conditions”.

Nuno Sousa Pereira, CEO of Sixty Degrees, points out that the rise in European sovereign bond yields “is more a reflection of the possible inflationary shock in the short term as a result of the escalation in oil prices, which is still expected to be contained over time”, which could “lead to an upward revision of the ECB’s key rates”. In the 10-year period, “the spread has risen in all countries, as Germany still functions as a safe haven for debt”.

The real test for Portuguese public finances is not what has already happened, but what is yet to come. The Portuguese Republic’s financing programme for 2026, approved by the Treasury and Public Debt Management Agency (IGCP) last December, forecasts financing needs of €29.4 billion, of which €24 billion is to be raised through Treasury bond issues, combining three syndicated issues and nine auctions.

To date, the country has placed approximately €8.28 billion in Treasury bonds on the market, leaving around two-thirds of its target, or €15.7 billion, still to be met. With yields rising and the ECB approaching a potential reversal of monetary policy, the cost of these issues may prove higher for the Treasury than was anticipated at the start of the year.

Nuno Sousa Pereira leaves clear strategic advice to the agency responsible for managing the national debt: “The IGCP should take advantage of any window of low volatility and issue long-term debt, if possible inaugurating longer lines, such as 50 years”, noting that “Portugal is experiencing a particular confluence of factors — stability, access to capital, labour costs and attraction of foreigners — that provides economic growth above the Eurozone”.

The reasoning of the Sixty Degrees leader is strategic: anchoring very long-term financing while conditions are still relatively favourable reduces exposure to future market shocks. The question is how long this window will remain open.

“Inflation expectations are still contained in the short term. As this conflict and its implications drag on, the curve may normalise with a rise in long-term rates, but it will take time or require a physical escalation of the conflict to be faster. If the conflict drags on, central bank intervention cannot be ruled out, especially in conjunction with private credit problems in the US that could spread”, warns Nuno Sousa Pereira.

Portugal remains standing, solid in its fundamentals, but more expensive for those who want to lend to it in the short term. The IGCP has a demanding schedule ahead and the markets rarely wait. The first test comes this Wednesday with two Treasury bond auctions for the line maturing in October 2033 and the line maturing in June 2025, for an indicative total amount of up to €1.5 billion.