Portuguese Prime Minister Jose Socrates warned of grave consequences for the country after parliament rejected his government's latest austerity measures aimed at avoiding a bailout.
Mr Socrates tendered his resignation in the wake of the parliamentary vote.
‘This political crisis has very grave consequences for the confidence Portugal needs from institutions and the financial markets,’ Mr Socrates said.
After the rejection of the measures, Portuguese yields could rise further unless a new government quickly comes up with a fresh austerity package.
However, forming a new government could take many weeks.
Mr Socrates and his socialists firmly opposed a bailout, which would carry tough fiscal conditions. Portugal has bad memories of IMF-ordered austerity in the 1980s.
Cabinet minister Pedro Silva Pereira said that the government will continue rejecting an international bailout.
He said: 'The government will continue to fight against the possibility of resorting to foreign aid. Our position is clear - rejection of foreign aid.
'Foreign aid would have very serious consequences for the economy.'
But the main opposition Social Democrats (PSD) have not ruled out seeking international aid.
PSD leader Pedro Passos Coelho has indicated he would seek political cover for any bailout by blaming the last government for it. Other, smaller parties are mostly against a bailout.
Countries such as Germany have been pressing Portugal to seriously consider a bailout, as a way of removing a major source of market instability in the eurozone. They could increase their pressure if Portuguese yields keep rising.
Bonds hit new highs
Meanwhile, Portugal's government bond yields hit new highs.
The country's borrowing costs are now seen as unsustainable, with ten-year yields above 7.9% and five-year yields at 8.5%.
It faces €4.8bn of bond repayments in April followed by €6.95bn in June.
This increases expectations that Portugal will need an EU/IMF rescue deal soon.
Separately this morning, Moody's cut the ratings of 30 Spanish Banks and London's biggest clearing house, LCH Clearnet, raised the margin it charges on Irish government bonds.
