GLOBAL banking giant Citi Group said there is a high chance that Ireland, Greece and Portugal will end up restructuring government debt over time, even though Citi's economists are optimistic about the global economic outlook.
All three countries were badly hit in the bond market yesterday, but an anaemic holiday market was blamed for at least some of the weakness.
It comes as the Greek government reacted with fury to rumours that it will default on its debt as soon as this weekend.
The Greek finance ministry said it had called on the Athens Public Prosecutor to investigate the spreading of rumours affecting financial markets, adding: "Such rumours are of course devoid of any substance and verge on the ridiculous."
Such umbrage is unlikely to deflect from Citi Group's downbeat assessment of Ireland and the other distressed euro countries in its monthly Global Economic Outlook and Strategy report.
Irish, Greek and Portuguese two-year government bond yields all hit euro-era highs yesterday. Investors dumped the bonds on fears that the debt crisis is set to enter a new phase if, as many expect, Greece reneges on its government loans.
If Greece restructures its debt it will make it far harder for Ireland to convince investors to lend to this country.
In its report Citi Group said Ireland is in danger of a restructuring because of the risk of killing off any economic recovery with the impact of spending cuts and tax hikes. Citi said a 14pc to 15pc fiscal adjustment is needed to reduce the Irish debt burden down to 60pc of GDP by 2030, the level agreed under the Maastricht Treaty.
"Such fiscal austerity would be likely to crush growth and hence lead to persistent revenue undershoots that would inhibit the return to fiscal sustainability," according to the report.
Citi Group warned long-term cuts would lead to "austerity fatigue" among voters and politicians in Portugal, Spain, Greece and Ireland. The political fallout would make it impossible to deliver the spending cuts and tax hikes needed to reduce deficits, it said.
Citi thinks Ireland is badly placed to benefit from the export boom driving growth in German and other core European markets.
If debt restructuring by countries does happen, Citi expects it to be "multi phase" with the maturity dates of government bonds pushed out first, followed by a reduction in interest rates and "haircuts" on the principal owed following eventually.
Citi said it is also concerned about health of European banks, and the economic outlook for Japan and the US.
The yield on two-year government bonds are being closely watched at the moment because they fall due before the new bailout mechanism, the European Stabilisation Fund, is launched in 2013.
The yield on Greek two-year bonds hit 22.52pc yesterday, a record for any euro member country.
The Irish two-year yield hit 11pc, also a record with Portugal's bonds due around the same time paying 11.2pc.
Gavan Nolan, an analyst with market monitoring company Markit, said the Easter holiday has exaggerated market movements.
He said that liquidity -- the amount of cash in the system -- was low this week.
Cash-starved markets are more susceptible to big price movements because there are fewer deals and fewer people considering prices.
Technical factors including some traders selling bonds because they have too much bond insurance also had an affect.
"Both the poor liquidity and dealers covering default exposure before the Easter holiday no doubt played their part in this week's widening," he said.