Portugal's caretaker government said on Wednesday it had decided to seek financing from the European Union in an abrupt turnaround after resisting a bailout for months despite sharply deteriorating financial conditions.

The nation of 10.5 million became the third member of the euro zone to seek a rescue after Greece and Ireland after months of fending off market pressure to request assistance, as borrowing costs soared amid deepening political instability.

Prime Minister Jose Socrates said in a televised statement that parliament's rejection of additional austerity measures last month had aggravated the financial situation, ultimately making the request for aid inevitable.

I tried everything, but in conscience we have reached a moment when not taking this decision would imply risks that the country should not take, he said.

Socrates cited no figure but a euro zone official estimated Lisbon is likely to need between 60 and 80 billion euros in European and International Monetary Fund loans over three years. Any assistance will be subject to strict conditionality.

The IMF said it had not received a request from Portugal for financial assistance but it stood ready to help. EU paymaster Germany insists on IMF involvement as a condition for bailouts.

Portugal's position worsened when the minority Socialist government resigned on March 23 after the parliamentary defeat, casting the country into political limbo. An early general election is set for June 5.

Bond yields spiked, ratings agencies downgraded sovereign and bank debt, and local banks warned this week they may no longer be able to buy government paper.

In this difficult situation, which could have been avoided, I understand that it is necessary to resort to the financing mechanisms available within the European framework, Finance Minister Fernando Teixeira dos Santos said.

The European Commission's top economic official, Olli Rehn, welcomed the Portuguese decision, saying it was in the interest of the 17-nation single currency area as a whole.

This is a responsible move by the Portuguese government for the sake of economic stability in the country and in Europe, Rehn told Reuters.

DEFICIT TARGET MISSED

EU officials have been striving to prevent financial market contagion spreading beyond Portugal to affect larger economies such as Spain, which has undertaken major economic reforms, budget cuts and a banking clean-up to stay out of danger.

Portugal has implemented a series of spending cuts, tax rises and wage curbs and the government proposed further measures to reduce the public deficit to 4.6 percent of gross domestic product this year after missing last year's 7.3 percent target. Following a restatement of public accounts, the 2010 deficit came in at 8.6 percent.

Socrates' caretaker government said last week it lacked the constitutional authority to negotiate an economic adjustment program with the EU and IMF, raising a potential obstacle to an early deal. The prime minister said he had made the request within the limits of his caretaker role.

Center-right opposition leader Pedro Passos Coelho said his Social Democrats, the main opposition party, which leads the Socialists in opinion polls, supported the aid request.

This needs to be seen as the first step in not hiding the truth, Passos Coelho said shortly after Socrates' announcement.

Polls suggest neither major party is likely to win an outright majority, raising the prospect of coalition bargaining.

Yet the country needs to make more than 10 billion euros in debt redemptions this month and in mid-June.

The call for external help from the Portuguese government will probably have a bigger internal impact ... rather than having a positive impact on interest rates, said Joao Leite, head of investment at Banco Carregosa in Lisbon.

Unfortunately, all solutions will only have an impact in the long term and until then the Portuguese have a hard road ahead, he said.

SWIFT PROCESSING

A European Commission statement said Socrates notified Commission President Jose Manuel Barroso of Portugal's intention to ask for the activation of EU financial support mechanisms and Barroso assured (him) that this request will be processed in the swiftest possible manner according to the rules applicable.

EU officials have said negotiations could move quickly but emergency loans are normally only disbursed once there is a signed agreement with a fully empowered government, ratified where appropriate by parliament.

A source close to French Finance Minister Christine Lagarde said Portugal's formal request would allow the opening of a joint assessment by the European Commission, the IMF and the European Central Bank to formulate a response.

An EU source the interest rate on loans for Portugal would depend on the timing of the deal and whether the euro zone's rescue fund has to borrow on the markets.

Euro zone and EU finance ministers are due to meet in Budapest from Friday to discuss Portugal's financing needs.

Earlier on Wednesday, the country managed to sell 1 billion euros in short-term treasury bills but at very high yields. The finance ministry said the auction was a confirmation of the deterioration caused by the rejection of the austerity measures.

Although Portugal's public debt is lower than Greece's or Ireland's at 92 percent of GDP in 2010, the country's chronic slow growth has raised long-term doubts about its solvency.

In general, we've been concerned about Portugal's fiscal challenges and not only think they need short-term financial help but also a high probability that Portugal has to restructure their debt, said David Leduc, chief investment officer of Standish, a division of BNY Mellon Asset Management.

Undermining efforts to avoid a bailout, local banks told the government on Monday it must seek a short-term emergency loan to soothe market concerns ahead of the election, saying that under current conditions they cannot continue buying government debt.

There has been a very important signal from the banks for the future, said BNP Paribas analyst Ioannis Sokos.

Portugal had to call in the IMF twice in the 1970s and 1980s, enduring draconian austerity measures imposed in exchange for emergency loans. The stigma attached to a foreign rescue is still searing in the public mind.

(Additional reporting by Shrikesh Laxmidas, Sergio Goncalves, Filipa Lima and Elisabete Tavares in Lisbon, Jan Strupczewski in Brussels; Writing by Axel Bugge, editing by Paul Taylor)

Portugal