|The ratings agency said the shock decision has exposed the “institutional limits” faced by Portugal’s leaders as they try to meet EU-IMF demands for retrenchment. “The ruling could be interpreted as saying that all public spending cuts that affect civil servants are unconstitutional. This raises concerns about how the government would implement further cuts. If that interpretation is correct, the ruling represents a setback,” it said.
The warning came as Portugal’s prime minister, Pedro Passos Coelho, said the country faced a “financial emergency” and vowed to slash spending on education and social security to plug the gap.
The court ruled that cuts targeted against public workers alone are unfair. Mr Passos Coelho said the decision would have “very serious consequences” for the country as it awaits the next tranche of loans under its €78bn (£66bn) “Troika” bail-out.
Julian Callow, from Barclays, said it was destructive to cut funds for schools since that undermines the country’s future growth. “They really are scraping the barrel. Studies by the OECD have repeatedly shown that Portugal needs to spend much more on education,” he said.
Yields on Portugal’s 10-year bonds jumped 24 points to 6.6pc on Monday, the highest this year, dashing hopes for a swift return to market access.
There was no contagion to other Club Med states. A tsunami of funds from Japan washed through EU bond markets on Monday as Japanese life insurers searched for yield, driving down Italian and Spanish yields.
Yet the political upset in Portugal has once again exposed the fragility of the eurozone as depression grinds on across the South, and austerity fatigue turns to anger.
Italy still has no new government six weeks after voters repudiated EU policies in an election in February, while Cyprus is in shock after EU creditor states imposed huge losses on bondholders at its two largest banks.
The Cypriot government revealed on Monday that it no longer has enough money in its reserve fund to pay salaries in April, warning that it needs fresh help to “avoid a default” on €75m by the end of the month.
The EU-IMF Troika said it had suspended all decisions on Portugal until there is clarity. German finance minister Wolfgang Schauble praised Portugal for taking its austerity medicine, but said the country must abide by the deadlines after being given two extra years to meet deficit targets. “Portugal has made lots of progress in the last year. But after this decision, it will have to find new measures,” he said.
Portugal has been held up as a poster-child of eurozone austerity, praised for boosting exports and slashing the current account deficit from 10pc of GDP to near zero.
However, Portugal started its retrenchment after Greece and is showing some of the same symptoms. The slump has proved deeper than expected. The budget deficit rose last year to 6.4pc of GDP from 4.4pc in 2011, despite the cuts. The economy contracted at a 3.2pc rate in the fourth quarter. The International Monetary Fund expects public debt to reach 124pc of GDP this year.
There are signs that Washington is becoming frustrated by Europe’s failure to put out its fires, with growing concerns that EU austerity policies are holding back global recovery.
The US is particularly irritated with Germany, after the country built up a current account surplus of 7pc of GDP last year, replacing China as the arch-villain.
Treasury secretary Jacob Lew told European Union leaders in Brussels on Monday that the eurozone’s hairshirt regime was becoming a serious concern. “Our economy’s strength remains sensitive to events beyond our shores and we have an immense stake in Europe’s health and stability. I was particularly interested in our European partners’ plans to strengthen sources of demand at a time of rising unemployment,” he said.
Washington had hoped that Europe would be well on its way to recovery by this time, able to take the baton of global expansion as America braces for its own fiscal shock over the rest of the year.