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London - Portugal's credit downgrade to "junk" status rocked European markets on Wednesday, sending the country's government bond yields to lifetime highs and hammering the euro as it raised the spectre that Lisbon may be forced to restructure its debt.
Risky assets took a beating and stayed under selling pressure after China raised its official interest rate, stoking some concerns that credit tightening in the world's No.2 economy may dampen the outlook for the global economy.
European shares slipped, snapping a seven-day winning streak, and US stocks were poised to open lower a day after Moody's warned Lisbon may need a second round of rescue funds before it can return to capital markets.
Investors were already dumping risky assets ahead of a monetary policy announcement by the European Central Bank on Thursday.
The ECB is all but guaranteed to raise interest rates by 25 basis points to 1.5%, but markets remain uncertain whether it will signal that further rates may be in store later this year.
Markets also braced for US payrolls data on Friday to see if an expected rise in monthly employment will be enough to convince investors that the US economy is continuing to recover.
Moody's rating cut for Portugal followed a Greek ratings downgrade by S&P to near-default status last month, before Athens managed to squeak through austerity measures which have staved off a possible restructuring for the moment.
"The key worry of the market is that the events that we've seen with Greece are being repeated with Portugal," said WestLB rate strategist Michael Leister.
The two-year yield on Portuguese government debt surged more than 2 percentage points to a lifetime high of 15.77%, while the 10-year yield climbed more than 1 percentage point to 13.45%, also its highest ever.
Other yields on bonds issued by weak, periphery euro zone countries shot up, widening their spreads against German ones as investors ploughed into the debt of the euro zone's strongest member nation.
Such demand helped to push Bund futures up 56 ticks higher on the day to 126.18.
Some analysts downplayed the initial market reaction to China's announcement it had increased interest rates for the third time this year.
The Australian dollar , which is sensitive to developments the Chinese economy due to Beijing's dependence on its natural resources, slipped to a session low of A$1.0663 after the news, but trading just 0.2% lower on the day.
US crude oil prices fell 0.6% to a session low around $96.25 per barrel on the news.
Analysts said that while the China rate move had been flagged, they were surprised that the market's initial reaction had not been bigger, as Beijing's attempt to tame inflation may lead to a cut in global demand for goods.
"There had been rumours earlier in the week of a rate rise ... There has been a slip in risk appetite since the announcement, but the move has been exceedingly minor," said Michael Derks, strategist at FXPro.
He added that European markets were firmly focussed on the Portuguese downgrade, but said US markets may show a bigger reaction to China's rate rise later in the day.
European stocks slipped 0.4% to 1 117.56, retreating from the highest level in more than a month hit the previous day.
US stock futures fell 0.4%, an early indication that US shares may open lower.
The MSCI world equity index slipped 0.3%. The index has taken a breather after shooting up more than 4% last week, its best performance in a year.
The euro slipped roughly half a percent on the day to a session low around $1.4330, extending losses from the previous day. Its losses versus the dollar prodded the greenback up 0.4% against a currency basket.
The euro took a beating across the board, as European investors dumped the single currency for ones considered to be safer havens, including the Swiss franc and the yen .
"Greece is a basket case and we will probably have Portugal and Ireland drifting in the same boat," said Steve Barrow, head of G10 currency research at Standard Bank.
"But for the ECB raising rates, we would have the euro falling pretty sharply. It is likely to hold in the $1.40-$1.50 range for now."
