October 21, 2016 / 10:52 AM / in 2 years

UPDATE 5-Portugal's bond yields near 6-week low as PM confident on ratings test

* Investment grade rating needed to qualify for ECB scheme

* Outlook in focus as well as rating (Updates prices)

By John Geddie

LONDON, Oct 21 (Reuters) - Portugal’s government bond yields fell towards a six-week low on Friday, after its prime minister said he had no doubt that rating agency DBRS would maintain the investment-grade rank the country needs to qualify for the ECB’s asset purchase scheme.

The Canadian ratings firm - the only one of the big four agencies that rates Portugal at investment grade - is due to present its review after markets close on Friday.

Analysts said that as regulation dictates that Portugal must be informed of the results a day before, the comments by Antonio Costa were seen as a strong hint that Lisbon would keep the key rating.

European Central Bank President Mario Draghi confirmed on Thursday that if Portugal were downgraded it would fall out of the quantitative easing programme.

If Lisbon, as some expect, announces a bond auction for next week on Friday, that would be another strong hint that the country has avoided a cut.

“We’re as certain as can be that there won’t be a downgrade,” said Lyn Graham-Taylor, fixed income strategist at Rabobank. “It may have been intimated to the government already.”

Investor angst over the decision has receded in recent weeks anyway, with the promise of budget deficit cuts in 2017 and renewed promises of left-wing support for Portugal’s government.

Portugal’s 10-year bond yield fell 4 basis points to 3.19 percent on Friday, within sight of a six-week low of 3.16 percent struck on Thursday, according to Tradeweb.

By 15.40 GMT, it was yielding 3.21 percent, still down 1.4 bps on the day.

The German 10-year bond yield - the euro zone benchmark - was flat around the zero percent mark after a brief dip into negative territory earlier in the day.

While there appears to be a broad consensus among analysts and investors that Portugal will dodge a downgrade, a change in its rating outlook from stable to negative is seen as possible.

“We expect the trend to be lowered to negative, which should cap the upside in Portuguese government bonds medium term, and we stick with our cautious strategic stance,” Commerzbank strategist David Schnautz said.

If DBRS cuts the outlook it would mean a greater likelihood of a rating cut at the next review in six months’ time.

Warnings by DBRS in August of risks to Portuguese creditworthiness, mainly from slowing growth and weakness of the banking sector, coupled with concerns over rising friction between Lisbon and the European Commission over its budget plans, have spooked markets in recent months.

Ten-year yields rose from around 2.70 in August to an eight-month high of 3.61 percent in early October, before edging back to current levels.

Commerzbank said yields should fall back to around 2.8 percent if Lisbon survives the review, while some investors have warned that yields could rise as much as 200 basis points if it is downgraded.

Without access to the programme, many analysts fear Portugal would need a new bailout.

Of other rating reviews due on Friday, analysts said there was a chance Standard & Poor’s could downgrade France, the EU’s second largest economy. S&P rates France at AA and has had it on a negative outlook for two years. (Reporting by John Geddie; Additional reporting by Dhara Ranasinghe; Editing by Alison Williams and John Stonestreet)

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