* Moody’s downgrades Spain rating by one notch
* Budget shows net debt issuance will drop in 2011 * Bond market reflects relief downgrade wasn’t steeper
* Budget expected to pass after deals struck
(Adds minister comment, background, updates prices) By Andres Gonzalez and Nigel Davies
MADRID, Sept 30 (Reuters) - Spain lost its final top-line debt rating on Thursday as the government sought parliament’s backing for a budget it hopes will convince financial markets it can cut its deficit while the economy struggles.
Moody’s was the third agency to cut the triple-A rating which has helped Spain finance its debt relatively cheaply but also aided excessive borrowing before an economic crisis took hold in 2008. Spain had held AAA status on all its ratings since 1998.
The cut had been expected and Moody’s said it hoped not to have to cut again soon, bolstering Spanish debt markets.
But the agency also said a poor growth outlook meant Spain would have to take further steps to meet its deficit targets in years to come — the key to seeing off a debt crisis which has threatened to engulf it as it did Greece earlier this year.
The Bank of Spain separately said that a sluggish recovery would slow further in the third quarter.
“A large part of the fiscal consolidation for this year and next is based on tax increases and measures that cannot be continued for many years,” Moody’s lead analyst for Spain, Kathrin Muehlbronner, told Reuters.
“Spain will need more structural measures to bring down its deficit.”
The government has slashed spending in the euro zone’s fourth biggest economy, hoping to differentiate itself from Greece, Ireland and Portugal as investors drive up the premium for borrowing to some of the euro zone’s high-deficit countries.
Millions of Spaniards joined a general strike on Wednesday to protest against public sector cutbacks — the budget envisages a 7.9 percent cut in spending for next year — labour reforms aimed at making it easier for companies to hire and fire, and plans to extend the retirement age to 67 from 65.
Unemployment was over 20 percent in the second quarter, twice the euro zone average, and the government revised up its forecast to 19.8 percent this year and 19.3 percent in 2011.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For a story on Moody's downgrade [ID:nLDE68T0FF] For a story on Spain's budget [ID:nLDE68T0BA] Spain will survive latest downgrade [ID:nLDE68T0KE] For a graphic on credit ratings r.reuters.com/get52k For an analysts view [ID:nLDE68T0NG]
Many economists believe budget cuts will push Spain back into recession this year, and Moody’s forecast average economic growth of just 1 percent over the next few years as the country tries to rebuild its property-dependent economy.
Economy Minister Elena Salgado told a news conference after presenting the budget to lawmakers that she expected Spain to be able to continue issuing debt at “very reasonable” cost, and that it would press on with its austerity plans.
Details from the 2011 budget showed a planned cut in net debt issuance next year to 43.3 billion euros from 76.2 billion euros this year. However, interest paid on the state’s debt in 2011 would rise to 27.4 billion euros, or 2.5 percent of GDP.
Socialist Prime Minister Jose Luis Rodriguez Zapatero’s minority government expects to pass the budget before the end of the year, having won the backing of the Basque National Party with concessions to autonomy in the northern Basque region.
The government also maintained a growth forecast of 1.3 percent for 2011 expansion of gross domestic product next year.
After the Moody’s announcement, Economy Secretary Jose Manuel Campa told Reuters the government was satisfied with the agency’s assessment of Spain’s fiscal measures as achievable this year.
But he criticized Moody’s view on growth. “We believe that outlook is excessively pessimistic,” he said.
The spread in Spain’s 10-year bond yields over benchmark German debt narrowed about seven basis points from a day earlier, to 189 bps. ES10YT=TWEB DE10YT=TWEB Comparable spreads on Irish and Portuguese bonds have soared well above 400 basis points on concerns over looming credit problems.
Spanish stocks .IBEX fell just around 1.0 percent, in line with other European markets.
“The one notch cut (by Moody’s was widely expected by the markets. But I would highlight the reference to Spain remaining vulnerable to further market stress, particularly in the context of its debt refinancing needs for 2011 and 2012,” Citigroup Economist Giada Giana said.
“I think the growth forecast of an average 1 pct annually for the coming years is still too high. We see 2011 growth close to flat or even negative for next year,” she said.
Writing by Fiona Ortiz; Editing by Patrick Graham and John Stonestreet