UPDATE 2-Fitch cuts Spain's ratings, markets tumble

Fri May 28, 2010 1:54pm EDT

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By Sonya Dowsett

MADRID May 28 (Reuters) - Fitch Ratings cut Spain's credit ratings to AA+ from AAA on Friday, saying its economic recovery would be more muted than the government forecast, pushing world equities and the euro lower.

The downgrade follows a cut by another agency Standard and Poor's last month and heaps more pressure on the government, battling to reassure markets its fiscal, political and social woes will not end up in a Greek-style debt crisis.

Fitch said Spain's deleveraging of record-high levels of household and corporate debt and growing levels of government debt would drag on economic growth.

"The downgrade reflects Fitch's assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term," Fitch's analyst Brian Coulton said in a statement.

It kept its outlook stable.

The downgrade by Fitch set off a new round of selling in equities that were already lower. The euro fell as low as $1.2284 EUR=EBS, near a session low.

Europe's clumsy response to a Greek debt crisis and big deficits in other euro zone countries have unnerved markets over the past six weeks and raised doubts about the viability of the euro.

"The markets are reacting negatively," said John Praveen, chief investment strategist at Prudential International Investments Advisers in the United States. "The European debt problem is going to continue to have a shadow on the markets."

Fitch said Spain's current government debt would likely reach 78 percent of gross domestic product by 2013 from under 40 percent before the start of the global financial crisis in 2007.

Spain's government debt is forecast to hit 65.9 percent of GDP by 2010, around half that of Greece.

The inflexibility of the labour market and the restructuring of the unlisted savings banks would hinder the pace of adjustment Fitch said.

The Spanish government is struggling to agree crucial labour reforms with unions and the threat of a general strike. It just managed to pass a strict austerity package on Thursday by a single vote.

S&P downgraded Spain's ratings one notch to AA from AA+ with a negative outlook on April 28, saying it expected the euro zone's fourth biggest economy to grow only slowly in the next few years.

Some commentators on Friday said the downgrade was not unexpected, and drew comfort from positive comments from the agency about Spain's sovereign credit profile remaining strong and its sound financial sector.

"The stable outlook should be a good sign, it shows the situation is only worth a downgrade, but this is about as good as the bad news is going to get," said Dirk Schnitker, a Madrid-based analyst at CM Capital Markets Bolsa.

Moody's is the only agency that has not downgraded Spanish sovereign credit rating and still gives it a rating of AAA.

(Additional reporting by Tracy Rucinski and Nigel Davies; Editing by Ron Askew)

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