Moody's cuts Spain by 2 notches, sees funding risks

A Spanish flag flutters over the Colon square in central Madrid May 28, 2010.

NEW YORK (Reuters) - Moody's Investors Service on Tuesday cut Spain's sovereign ratings by two notches, saying

high levels of debt in the banking and corporate sectors leave the country vulnerable to funding stress.

Worsening growth prospects for the euro zone will also make it more challenging for Spain to reach its ambitious fiscal targets, the ratings agency added.

Spain could be downgraded again if the euro zone debt crisis escalates further, Moody's warned.

"Since placing Spain's ratings under review in late July, no credible resolution of the current sovereign debt crisis has emerged, and it will in any event take time for confidence in the area's political cohesion and growth prospects to be fully restored," Moody's said in a report.

The downgrade puts more pressure on euro-zone leaders, who will meet this weekend to discuss a solution for the crisis. Britain's Guardian newspaper on Tuesday reported that Germany and France have agreed to boost the euro zone's bailout fund to 2 trillion euros, causing markets to rally.

Moody's downgrade on Spain was the third received from the big-three ratings agencies in the past few weeks. Moody's was more aggressive than its rivals, however, cutting the country's ratings to A1 from Aa2.

Standard & Poor's and Fitch Ratings both have Spain one notch higher.

Market analysts said the news, although not unexpected, highlighted the seriousness of the European debt crisis.

"If the euro zone can't figure a way to handle the situation, you are going to see Spanish yields continue to go up, and they are going to have a problem to funding themselves," said Jessica Hoversen, currency and fixed income analyst at MF Global in New York.

(Additional reporting by Richard Leong and Daniel Bases; Editing by James Dalgleish and Leslie Adler)