Source: BNN (Business News Network)

Conditions attached to a 78 billion euros bailout of Portugal’s debt-ridden economy are likely to propel it into a deep recession for two years¸ an official source said on Wednesday.

Caretaker Prime Minister Jose Socrates announced late on Tuesday the country had reached a three-year bailout agreement with the European Union and International Monetary Fund after weeks of negotiations with the third euro zone country to seek foreign assistance¸ after Greece and Ireland.

European Union and IMF officials were due to meet Portugal’s main opposition on Wednesday to secure its agreement for the bailout terms¸ with elections due in a month.

Socrates said the agreement represented a victory for Lisbon¸ as it avoided very tough measures which Greece and Ireland were saddled with when they were bailed out last year.

But an official source told Reuters the austerity measures to be included in the deal¸ such as higher taxes¸ point to a “contraction of 2 percent in gross domestic product in 2011 and in 2012.”

That will make it yet more challenging for the heavily indebted country¸ which has had some of the lowest growth rates in Europe for a decade¸ to ride out its crisis and return to financial health.

The source told Reuters taxes will rise on cars and property and there will be cuts in deductions on health¸ education and housing.

Jonathan Loynes¸ chief European economist at Capital Economics¸ also forecast a 2-percent contraction this year.

“Against this background¸ while the confirmation of the bailout should provide some reassurance that Portugal will be able meet its upcoming bond redemptions¸ it won’t put an end to speculation that — along with Greece and perhaps others — it will sooner or later need to undertake some form of debt restructuring¸” he said.

The announcement of the deal did provide some relief in the bond market¸ where Portuguese yields fell for the first time in many weeks.

Yields on Portuguese 10-year bonds¸ which hit a euro lifetime record of 10.32 percent on Tuesday¸ fell to around 10 percent and the spread to German Bunds fell to 677 basis points from Tuesday’s highs of 707.

Portugal was forced to seek a bailout after its government collapsed last month¸ sending its borrowing costs soaring.

In a reminder of the challenges Portugal faces in selling debt¸ it will hold a treasury bill auction on Wednesday to issue up to 1 billion euros of 3-month bills.

DEFICIT GOALS EASED

Lisbon won some leeway for its austerity drive from its lenders. This year’s budget deficit target was raised to 5.9 percent of gross domestic product from 4.6 percent previously.

That still represents a sharp cut given the deficit totalled 9.1 percent of GDP last year and¸ under the deal¸ it must be lowered to 4.5 percent of GDP in 2012 and 3 percent in 2013.

The bailout deal includes up to 12 billion euros for t