By Sergio Goncalves
LISBON (Reuters) - Debt-ridden Portugal suffered another blow on Wednesday when its borrowing costs rose sharply in a government Treasury bill auction, but officials insisted the country could survive without an international bailout.
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All the 500 million euros in 12-month T-bills on offer in the auction were sold. But yields rose to a euro lifetime record of 5.281 percent from 4.813 percent two weeks ago, demonstrating sagging investor confidence in the Iberian nation which is now in the frontline of the euro zone debt crisis.
"Should bond yields not ease soon, there is a significant chance of Portugal being the next country having to seek an EU bailout," said Diego Iscaro, an economist at IHS-Global Insight in London.
A defiant Prime Minister Jose Socrates denied on Tuesday night that Portugal needed to seek a rescue. "We don't need any help. We will do all we can ourselves," he told reporters.
Germany's Economy Minister Rainer Bruederle offered him support just before the bond auction, saying he did not believe Portugal and Spain would need to tap euro zone rescue funds.
But the Standard & Poor's rating agency said on Tuesday it might cut Portugal's credit rating.
The minority Socialist government is trying to demonstrate that Portugal can avoid becoming the latest euro zone domino to fall after Greece and Ireland, hoping that tax rises and cuts in public spending planned for next year will do the trick.
Ireland agreed an 85 billion euro ($113 billion) bailout from the European Union and the International Monetary Fund last weekend -- even though the Dublin government had said none was needed until shortly before it asked for help.
Economists fear that unless Portugal takes the same medicine, the contagion will spread to its neighbor Spain, a considerably larger economy whose rescue could strain EU funds.
Spanish investors are heavily involved in Portugal, especially banks. Ironically, Wednesday was a public holiday in Portugal marking independence from Spain in 1640. Lisbon markets were open but with reduced staff.
Portugal's Treasury Secretary Carlos Pina attributed the rise in yields to speculative pressures. Rumors that Portugal was under pressure to request an aid package were harmful and had to stop, he told Reuters on Wednesday.
"A bailout never normalizes markets...Portugal does not need a bailout," Pina said.
The demand at the T-bill auction showed Portugal maintains the capacity to finance itself, Pina said. He also reiterated the government's commitment to meeting ambitious budget deficit targets this year and next, of 7.3 percent of GDP and 4.6 percent of GDP respectively.
ROWING TO BAILOUT
But Filipe Garcia, president of Informacao de Mercados Financeiros consultants in Porto, said the debt auction was the latest development pushing Portugal toward a bailout.
"What worries me most is that if the state only manages to get financing at these rates, how much will companies that have to turn to the international markets for financing have to pay?" he said.
Socrates last week pushed through an austerity budget which will raise taxes and cut public sector wages. So far this year the government has been unable to cut spending as planned.
The government expects the economy to grow at least 1.3 percent this year, mainly thanks to rising exports, after last year's 2.6 percent contraction. Next year it predicts an expansion of just 0.2 percent and many economists say the economy will slide back into a recession.
(Additional reporting by Andrei Khalip, Writing by Angus MacSwan, Editing by David Stamp)