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DUBLIN (Reuters) - Moody's Investors Service slashed Ireland's credit rating by five notches to Baa1 with a negative outlook from Aa2 on Friday and warned further downgrades could follow if Ireland was unable to stabilize its debt situation.
Ireland's debt levels have quadrupled since late 2007 on the back of a banking sector meltdown, and it needs solid economic growth to ensure it can meet repayments and fiscal targets set down in the 85 billion euros EU/IMF bailout agreed last month.
Moody's downgrade followed Fitch's move last week to become the first ratings agency to strip Ireland of its 'A' credit status, cutting it by three notches to BBB+ following the debt-stricken government's request for an EU/IMF bailout.
S&P is the only ratings agency that still has Ireland in the top band but that may not last long as it has its A rating on review for a possible downgrade.
"While a downgrade had been anticipated, the severity of the downgrade is surprising," Dublin-based Glas Securities said in a note.
The move pushed Irish 10-year government bond yields 7.5 basis points higher to 8.522 percent, and the yield spread over German Bunds rose about 10 bps wider on the day to 551 bps.
The Portuguese/German spread also widened about nine basis points to 364 bps while the Swiss franc climbed to an all-time high against the euro after the downgrade renewed pressure on the single currency.
While a pre-Christmas market lull may have led to a temporary truce in the onslaught against peripheral euro zone debt, ratings agencies have been busy flagging up the fact that risks are undiminished.
Just prior to its downgrade of Ireland, Moody's said late on Thursday that it had put Greece's Ba1 rating on review for a possible downgrade, citing uncertainty over the country's ability to cut debt to sustainable levels.
Moody's put Spain's debt on review for a possible downgrade on Wednesday, highlighting concerns over a funding crunch next year, although it said it did not expect Madrid to have to resort to a bailout as Greece and Ireland have.
And Standard & Poor's said this week it may cut Belgium's debt rating if the country's inability to form a government threatened deficit- and debt-reduction goals.
Moody's said the crystallization of bank related contingent liabilities, increased uncertainty regarding the country's economic outlook and decline in the government's financial strength were the key drivers of the action.
While Ireland avoided slipping back into recession in the third quarter -- posting gross domestic product growth of 0.5 percent -- the modest upturn underlined the huge challenge ahead in tackling its financial crisis.
Moody's said Ireland's uncertain economic prospects were amplified by its required four-year, 15 billion euro budget-cutting plan, which it said is likely to weigh on domestic demand and further drag on the country's recovery prospects.
"Should Ireland's adjustment capacity prove to be insufficient to stabilize debt metrics in the foreseeable future, a further rating downgrade would follow," Moody' said.
Editing by Hugh Lawson