* Tax hikes likely, analysts say VAT hike on the cards
* President meets political parties for second day
By Axel Bugge
Portugal's president opened a second day of talks with political parties on Wednesday to reach a deal on the 2011 budget as newspapers reported the government was considering tax rises.
Diario de Noticias and Publico said the government wanted to push through tax hikes in order to meet this year's deficit target and prepare next year's budget bill. Analysts say a rise in VAT sales tax is likely.
President Anibal Cavaco Silva was meeting leaders from the ruling Socialists and the main opposition centre-right Social Democrats (PSD), who hold the key to passing any budget measures in parliament because the government lacks a majority.
Investors have dumped Portuguese bonds in recent days, fearing the country will fail to cut its budget deficit. The spread on its 10-year government bonds versus German bunds reached euro lifetime highs on Tuesday above 450 basis points.
The spread was at 444 basis points on Wednesday but Portuguese credit default swaps, or the cost of insuring against default, hit a record high of 465 basis points, up 19.
Parliament Affairs Minister Jorge Lacao said there would be a cabinet meeting on Wednesday, without spelling out details of the agenda. "But it is known that the government is working intensely to reach its budget goals, to ensure control of the deficit this year and to reach the proposed goal for 2011," he told Antena 1 radio.
Paulo Portas, leader of the second-largest opposition party, the rightist CDS-PP, said after meeting the president that the government should focus on cutting spending, and he would only announce his position on the 2011 budget after it was presented.
"The priority is to cut spending. We do not accept arguments of tax hikes being unavoidable," he told reporters.
GROWTH CONCERNS
Economists worry that more measures to reduce the budget deficit could cut Portugal's recovery short, sapping consumer morale. The government expects growth of 0.7 percent this year after the economy contracted 2.6 percent in 2009.
"Any measure would have a negative impact on growth in the short term, implying a reduction in disposable income in one way or another," said Cristina Casalinho, an economist at BPI. "The short-term objective of the austerity measures, especially tax hikes, is not growth."
Manuel Carvalho da Silva, head of the CGTP umbrella trade union, said workers could intensify industrial action, even though strikes have so far won little broad support.
"We are going to intensify and increase the threshold of industrial action," he told business daily Jornal de Negocios.
Concerns are rising in the country that the crisis could escalate. "I think it's total chaos. I will retire soon but I don't know if there will be any money to pay me for my pension," said Fatima Ferreira, a school coordinator in Lisbon.
Diario de Noticias said the government was likely to approve a hike in taxes -- a recommendation made this week by the Organisation for Economic Cooperation and Development (OECD), which said Portugal needed to move quickly to fix its budget deficit to gain investor confidence.
Analysts say a rise in value-added tax, hitting consumption, is one of the most likely measures.
Last week, the PSD rejected a deal with the government to support the budget, to be presented to parliament by Oct. 15, saying it would not approve further tax hikes but instead wanted the government to focus on spending cuts.
The government has said it will resign if it cannot find support in parliament for the 2011 budget. Earlier this year the Social Democrats backed some tax hikes and other measures.
Portugal has so far failed to rein in the central government deficit, falling behind countries like Greece, Spain and Ireland whose debt levels are also under scrutiny from investors. It rose 5 percent in the first eight months of 2010, while Spain slashed the gap by 40 percent.
The government has promised to cut the overall budget deficit to 7.3 percent of gross domestic product this year and to 4.6 percent in 2011 from last year's 9.3 percent. (Additional reporting by Daniel Alvarenga; editing by Mark Trevelyan)