Investors fear contagion may spread across the eurozone after Ireland announced it was seeking a bailout last week.
Ireland is not scheduled to tap bond markets until next July. Other eurozone nations, particularly in the Mediterranean countries, do not have such a luxurious timescale.
Jan Randolph, the director of sovereign risk at IHS Global Insight, says the Irish debt crisis may have a knock-on effect on Portugal and Spain, both of which are already struggling with rising bond yields.
According to Randolph, the crisis may spread as far as Germany, whose revenues will be diverted into loans to struggling countries such as Greece.
In Ireland, general funding market conditions have become increasingly challenging over the past two months. (article continues below)
Allied Irish Banks says the environment has hit its funding position. It says customers withdrew €13 billion (£11 billion) from AIB accounts this year.
Anglo Irish Bank, state-owned but the biggest private borrower in Ireland, persuaded holders of its 2016 bonds to swap them for floating rate notes that mature in 2011. This will lower its cost of funding ahead of the Irish bail-out.
Many observers worry that peripheral eurozone countries may also start struggling to contain borrowing costs as well as meeting ambitious but necessary fiscal adjustments.
In particular, Portuguese bond yields rose last week well beyond the International Monetary Fund’s 5% interest rate for Greece and, most likely, for Ireland.
“As borrowing costs rise for other eurozone members because of lingering Irish banking problems, the idea of ring-fencing Ireland with a firewall has come to the fore, just as we saw with Greece in May,” Randolph wrote in a research note published last week.
“Throwing Ireland a credit life-line from the newly set up European Financial Stability Fund may stem the contagion and emerge as the cheaper option for all involved.”
For Greece and Portugal, on the other hand, the problem originates in fiscal and banking issues. Randolph says both countries need to demonstrate fiscal responsibility and stick to it.