Portugal's Prime Minister Pedro Passos Coelho

When Portugal’s government buckled this week and bond yields spiked, observers feared two conclusions: That the public tolerance for austerity-led reform programmes had been exhausted and that the wider eurozone crisis was poised to reawaken after a spring slumber.

Yet a few days on, the remarkable thing may be that the immediate consequences look far less troubling.

In Lisbon, the leaders of the two coalition parties were planning to spend the weekend hammering out the details of a new political agreement after the resignation of two senior ministers brought the government to the brink of collapse.

Pedro Passos Coelho, the country’s embattled prime minister, said the talks had already produced “a formula to maintain government stability” – even though it was not clear whether Paulo Portas, leader of the junior coalition partner, could be persuaded to remain in government after announcing his “irreversible” decision to quit.

Should the political turmoil result in a snap election, all the mainstream parties remain committed to the adjustment programme – with differing degrees of emphasis – and there is little prospect of anti-European protest movements emerging.

“The broad support is still there even if there may be an adjustment in terms of how you distribute it,” said Gilles Moec, a Deutsche Bank analyst.

That may be one reason why, after an immediate tremor, bond yields in other eurozone countries appear to have suffered little lasting damage from the Portuguese turmoil - something that would have been hard to imagine a year ago.

“Recent developments in Portugal do not mark the return of the crisis or create significant contagion risks,” said Mujtaba Rahman, head of European analysis at Eurasia Group risk consultancy, citing a variety of factors for the eurozone’s resilience – from a strengthened bailout system to the promise of the European Central Bank to shore up wobbling bond markets.

Portugal was not the only source of unease in the eurozone this week. Greece was plunged into a familiar showdown with its creditors after they warned on Tuesday that they would withhold an €8.1bn loan payment because of Athens’ slow progress at reducing its public sector workforce.

The two sides were expected to work through the weekend trying to close an agreement ahead of a Monday meeting of eurozone finance ministers. Although the outcome remained uncertain, Greek officials expressed confidence on Friday that a deal – for at least some of the money – appeared to be within reach.

Even if the worst fears about the eurozone crisis did not materialise this week, that did not rule out the possibility that they could the next time around. Greece and Portugal continue to labour under reform programmes that have so far yielded record unemployment but few tangible signs of hope. Among analysts, there is a broad consensus that both will need additional support from their eurozone partners beyond their current programmes.

As if to emphasise the point, Standard & Poor’s on Friday revised its outlook on Portugal from stable to negative on Friday, citing growing political uncertainties. “In our view, this week’s ministerial resignations complicate Portugal’s already-challenging policy making environment and suggest even less room for manoeuvre than when we changed the rating outlook to stable in March 2013,” the ratings agency said. S&P’s BB rating of Portugal’s long-term sovereign debt is currently a notch below junk status.

Indeed, Lisbon must still push through tough reforms, including large-scale public sector layoffs and €4.7b in spending cuts, to complete its adjustment programme. Any easing up in the pace of reform by a fractured government would make it increasingly unlikely that Portugal could exit its bailout on schedule by mid-2014.

“The real question is whether these programmes are capable of generating good outcomes?” Mr Rahman said. “The mismatch between programme compliance and economic performance is jarring, especially in Portugal.”

In Brussels, policy makers seem to finally understand that, with the European commission, the EU’s executive arm, scrambling in recent months to sweeten the austerity medicine. Most notably, it has given France and Spain additional time to meet fiscal targets. This week the commission told governments that some public investments they make will not count against those targets.

During a visit to Vilnius, José Manuel Barroso, the commission president, said on Friday that the Portuguese sell-off should serve as a signal to all crisis countries that they need to stick to their economic reform agendas, arguing markets feared any sign of slackening.

At the same time, he reiterated controversial remarks of April about the limits of austerity, saying that recent events in Portugal and Greece were examples of where the crisis response had come up against political limits and must be accompanied by new investments to increase employment and spur growth.

“There are some limits, political and social limits, to a policy that is only seen as fiscal consolidation,” Mr Barroso said. “A policy can be seen as right, but the politics will not [always] follow the policy. In a democracy, we need the politics to follow the policy.”

Additional reporting by Dimitris Kontogiannis in Athens and Peter Spiegel in Vilnius

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