Portugal Left Bloc sees government deal possible, shares fall

LISBON (Reuters) - Portuguese shares fell sharply on Monday after a second far-left party said it could back the main opposition Socialists to form a government, raising the possibility that budget policies imposed during its bailout will be abandoned.

The Left Bloc also said Pedro Passos Coelho, now serving as caretaker prime minister after his centre-right coalition won the most votes but lost its parliamentary majority in an Oct. 4 election, would fail to win enough backing to govern again.

The inconclusive election result left markets largely unmoved last week, but the prospect of prolonged political uncertainty as Portugal's divided left tries to form a government unsettled investors on Monday.

Shares in banks were hit particularly hard. The largest listed lender, Millennium bcp, slumped more than 9 percent, dragging Lisbon's stock index 3 percent lower. Bond yields, cushioned by the European Central Bank's asset purchases, were little changed.

"The next few weeks will be a test for the political environment and risk is already up," said Banco Best trader Alfredo Mendes. "Banks are the engines of the economy. If there are signs that the economy will be rudderless because there is no government, banks could be weakened."

Economists fear that a change in economic policy or a long delay in forming a government could undermine the Portuguese economy's revival after three years of recession made worse by harsh austerity imposed under a now-completed bailout.

Left Bloc leader Catarina Martins met with Socialist counterpart Antonio Costa on Monday, days after the Communist party said it would back a Socialist-led administration.

Together, the three parties hold a majority in parliament, but there are large policy differences between them and a leftist had been seen as unlikely.

"The (centre-right) government is over as of today, because it will not have support in parliament, but also because there is another government solution that corresponds to people's expectations and that can be the alternative that the country needs," Martins said.

"Conditions have been created for a basic consensus on the Left Bloc's terms for allowing the creation of a government."

Socialist leader Antonio Costa said there were "possible points of convergence" with the Left Bloc, especially on how to give more disposable income back to the Portuguese.

"The last two meetings have run very well, this last ran in a very interesting fashion. But it is premature to say whether an agreement is possible," he added.

Costa was due to meet President Anibal Cavaco Silva later on Monday and see Passos Coelho again later this week.

Passos Coelho's centre-right grouping could rule as minority government but it would need support from the Socialists to get legislation through parliament. It holds 104 seats in the 230-seat parliament, against the Socialists' 85 seats, 19 for the Left Bloc 19 and the Communists' 17.

Political scientist Adelino Matlez said the Communists' stance was a biggest game-changer as the party had signalled it is ready to "enter the system and become institutional" rather than remain a constant opposition force.

"The possibility of a leftist government is beginning to loom, which means we could be on the verge of a major change in the political landscape," Matlez added.

"Everything now is about the negotiations, about bargains ... (Passos Coelho) by now knows that Costa is not just bluffing, so his next proposal should be bolder."

(Additional reporting by Daniel Alvarenga; Editing by Catherine Evans)

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