By PAUL HANNON
LONDON—Moody's Investor Services Inc. on Monday cut Ireland's credit rating, citing a rising debt burden, a weak growth outlook and the high cost of rebuilding a shattered banking system.
The ratings agency lowered Ireland's credit rating to Aa2 from Aa1, with a stable outlook, indicating that it isn't likely to consider a further downgrade soon.
The Irish economy was the first in the euro zone to enter a recession, from which it only emerged in the first quarter of this year. It was hit particularly hard because excessive bank lending drove a construction boom that came to an abrupt end in 2008 when the banks ran into difficulty.
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With tax revenues plummeting and the costs of bailing out the banks mounting, the government's debt rose to 64% of gross domestic product at the end of last year from 25% of GDP before the financial crisis.
The ratings agency said it expects the government's debt to stabilize at between 95% and 100% of GDP over the next two to three years.
"Today's downgrade is primarily driven by the Irish government's gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability," said Dietmar Hornung, Moody's lead analyst for Ireland.
The downgrade led to an immediate rise in borrowing costs, as the spread between Irish and German government bonds with a maturity of two years, rose by 0.08 percentage point to 1.93 percentage points.
[ireland0719] European Pressphoto Agency
Moody's expects Anglo Irish Bank to need further support.
The first test of how the downgrade will affect demand for Irish debt will come Tuesday, when the government attempts to sell between €1 billion ($1.29 billion) and €1.5 billion of six-year and 10-year bonds.
The Irish government responded earlier and more decisively to the rise in its budget deficit than other euro-zone members, and that has helped limit the rise in its borrowing costs during the currency area's debt crisis.
However, the Moody's downgrade comes on top of the publication last week of a negative report from the International Monetary Fund, which said the government won't be able to meet its target of cutting the budget deficit to 3% of GDP in 2014 without further spending cuts and tax increases.
In addition to the high levels of government debt, Moody's said the prospect of three to five years of weak growth contributed to its decision to demote Ireland to its third from its second-highest sovereign rating category.
A third factor was the rising cost of bailing out the banks, with recapitalization measures announced to date costing €25 billion, while more help may be needed. "Moody's expects that Anglo Irish Bank may need further support," the rating agency said.
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The downgrade brings Moody's rating of Irish government debt into line with that of Standard Poor's Corp., which cut Ireland to double-A in June 2009. Fitch Ratings rates Ireland one notch below, having cut it to double-A-minus in November 2009.
Last week, Moody's downgraded Portugal's government debt two notches to A1, also citing the government's weakening financial strength and meager economic-growth prospects.
Analysts said that if the agency is consistent in reviewing its ratings of euro-zone governments, Italy may be next to suffer a downgrade.
"Nothing on Italy yet, but considering that there is a two-notch differential between Moody's and S&P, it would not be a major surprise if Moody's didn't take a look at Italy next," said Gary Jenkins, head of fixed income strategy at Evolution Securities.