Despite the new year, the volatility in equity markets, and even the highly uncommon sight of English cricketers outperforming their Australian rivals by some margin, there is still one story dominating European financial markets – the sovereign debt crisis. And after somehow managing to avoid the executioner in late 2010, especially after Ireland was forced into an early bail-out, Portugal is once again firmly in the firing line. The spread on ten-year Portuguese bonds, compared with German bunds, is back up above 400bps, and the market is smelling blood.

The Portuguese government, meanwhile, is still protesting that it does not need help. Indeed, Portugal's efforts to rein in its deficit have been relatively impressive, given the country's pretty poor fiscal track record. The minority government swiftly sought cross-party consensus with the opposition back at the start of the crisis, and together they have pushed through measures to raise taxes and cut wages in an effort to stave off a fiscal crisis.

The problem is that this is probably all too little, too late. While the recent flurry of activity is welcome, fundamentally the Portuguese government was not in a good place when the crisis hit. Ireland provides some useful context here. Over the next three years – 2011 until the end of 2013 – the Irish government faces debt repayments and interest totalling around €35bn. Portugal, by contrast, needs €63bn. Wednesday's auction of 3Y and 9Y bonds will be key: if the government fails to raise a decent sum, which for Portugal is probably somewhere around €2bn, the pressure will only intensify, driving spreads up and the Republic into the arms of its neighbours and the IMF. And given that Portugal has to find €16bn over the next four months alone, it could all happen far too quickly – for my money, even the large T-Bill repayments on 18 February and 18 March look like obvious pressure points.

In fact, a swift bailout for Portugal- either due to market pressure or pre-emptive moves by its neighbours, as was the case with Ireland ' would be much better than a protracted struggle to avoid intervention. With Greece and Ireland already supported, there is still a little under €690bn available to support euro area economies from the hastily assembled Financial Stability Facility (FSF). Ticking Portugal off the list as well – probably for around €80bn – would help remove another domino from the stack.

After that, there is still a lot to play for. By my reckoning, the funds that would remain in the FSF would be sufficient to cover both Spain and Belgium until the end of 2013 – although market and media chatter about the latter are still overblown, given that Belgian spreads are smaller than both Spanish and Italian ones. Italy would then be the major threat, but that is nothing new. From the day the crisis broke, it has always been clear that if Italy gets into trouble then all bets are off.

By using the FSF prudently, then, Europe can still buy itself time to get its house in order. With that in mind, the initial moves by politicians back at the end of 2010, to set up a framework for dealing with default and restructuring after 2013, need to be reinvigorated and accelerated. The sooner Europe can agree how to deal with a Greek default in 2014 – notwithstanding the fact that to get that far it will need far more funding than the existing €110bn bailout package – the sooner financial markets can digest the implications, and get used to the idea. That will significantly increase the chances of an orderly default, rather than a disorderly one, thereby minimising collateral damage (which would still be significant!). And if, by some major miracle, Greece manages to eliminate its deficit in the meantime, so much the better. In fact, a clear resolution regime should act as a spur to those countries that have been bailed out to press ahead with reform ever more quickly.

Unfortunately, of course, all of this once again falls foul of the same old problem – European policy-makers. With drive, a clear sense of the common good, and early support for Portugal, Europe could still be the master of its own destiny, albeit a destiny where someone defaults. But if policymakers match their previous track record, the chances of such decisive, reassuring action are sadly slim.

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