SYDNEY/LISBON (Reuters) - Standard & Poor's affirmed Portugal's BB credit rating on Friday after reviewing it for a possible downgrade, but retained a negative outlook on the rating, which is two notches below investment grade.
The rating agency's decision to remove Portugal from Creditwatch negative represents a slight improvement in its outlook ahead of the country's planned exit from its bailout this year and as it emerges from a prolonged recession.
But the move is already priced into Portuguese bonds following a recent rally, with some players expecting further improvements in the country's ratings this year.
The yield on Portugal's benchmark 10-year bonds was flat at 5.159 percent on Friday.
S&P said the move reflects its expectation that Portugal will achieve its 5.5 percent of GDP budget deficit target in 2013 and approach its 4.0 percent target in 2014.
"We base this expectation partly on indications that the economy has been showing signs of stabilization since mid-2013," S&P said in a statement. "Stronger-than-expected export performance, and an expected bottoming out of private consumption, amid a modest decline in unemployment should support Portugal's fiscal performance in 2014."
S&P said a key risk was the possibility the Constitutional Court may reject more austerity measures after previously ruling out some spending cuts, although it expected the government to find alternative measures as it has done in the past.
Lower-than-expected growth, slippage in the primary fiscal balance, and possible judicial or opposition challenges to the 2014 budget were also cited as risk factors.
"The negative outlook reflects our opinion that there is at least a one-in-three possibility that we could lower our ratings on Portugal during 2014," the rating agency said.
Last week, Lisbon sold 3.25 billion euros of five-year bonds and on Wednesday placed short-term debt at the lowest yields since late 2009 - long before its mid-2011 bailout. The successful sales provided fresh evidence that the country's chances of regaining full market financing are improving.
Portugal's economy started to recover from its worst downturn since the 1970s in the second and third quarters of last year. The government hopes the improving economy will allow it to exit the 78 billion euro bailout as planned in mid-2014 and return to fully financing itself in bond markets.
Most economists say Lisbon is likely to need a standby credit line when the current bailout expires, unlike Ireland which made a "clean exit" from its programme last month.
Another rating agency, Moody's, had been expected to release a statement on Portugal last week, in line with new European Union rules that require agencies to say when they will review a country's ratings. It did not do so, however, saying it was not obliged to if it made no change to its stance.
Moody's rates Portugal Ba3, three notches below investment grade. In November, it raised its outlook on the rating to stable from negative, the first positive action on Portugal by any of the three big credit rating firms since its political crisis in the summer of 2013.
Fitch rates Portugal just one notch into junk territory at BB+ with a negative outlook.
(Reporting by Thuy Ong and Andrei Khalip; Editing by Catherine Evans)