July 13, 2010 / 8:15 AM / 9 years ago

Moody's cuts Portugal rating, central bank sees slowdown

LISBON (Reuters) - Portugal’s debt-ridden economy will struggle to grow next year, its central bank and Moody’s Investor Service said on Tuesday, as the credit agency cut the country’s rating and forecast more austerity in 2011.

The two-notch downgrade to A1, with a stable outlook, briefly hit the euro, but broad market reaction was relatively muted as Moody’s made up ground with rival agency Standard & Poor’s, which still rates Portugal two grades lower at A-.

“It doesn’t have the same impact as it would if the likes of S&P were to downgrade, given the move only brings (Moody’s) in line,” said Sean Maloney, rate strategist at Nomura.

Moody’s said structural weaknesses meant the economy’s prospects were poor, and the Bank of Portugal warned a new recession was possible as it cut its growth estimate for 2011 to just 0.2 percent from 0.8 percent.

Lumbered by higher than average levels of household debt and a relatively low savings rate, Portugal had its rating cut by two notches in April by S&P, which also gave a negative outlook.

The gap in the pace of ratings changes by the two agencies echoed their treatment earlier this year of Greece, whose debt crisis unleashed financial turbulence in other parts of the euro zone periphery. S&P cut Greece to ‘junk’ status in April with Moody’s not following suit until June, when it downgraded by four notches.

But Anthony Thomas, vice president of Moody’s Sovereign Risk Group, told Reuters that Portugal’s rating remained at the high end of investment grade and the stable outlook meant there was no revision planned for at least 12 months.

The premium investors demand to hold 10-year Portuguese bonds rather than safer German Bunds rose slightly, edging up 6 basis points to 291 bps from Monday’s settlement level.

SLOWDOWN LOOMS

The central bank also upped its growth forecast for 2010 to 0.9 percent from 0.4 percent after higher-than-expected growth in the first half of the year, but said a sharp slowdown in the second half was likely to intensify in 2011.

Portugal’s GDP contracted by 2.7 percent in 2009.

“There are risks of a new recession in the projected timeframe (through 2011),” the central bank said in its summer economic bulletin. It also said Portugal was among various European countries that may need further budget consolidation.

Moody’s Thomas agreed, saying that while the government’s budget consolidation targets for this year looked credible, “there is a strong pressure ... to meet 2011 targets and we believe it will come up with more measures in the 2011 budget.”

Portugal’s finance ministry said in a statement the downgrade had been expected by the markets, and the stable outlook signaled Moody’s “confidence in the current economic policy strategy of the Portuguese government.”

Filipe Garcia, economist with consultants Informacao de Mercados Financeiros in Porto, agreed there was no “perception of a deterioration in the financial situation or of great difficulties in the treasury.”

But “it is still a warning about the need for structural reforms in the economy, because, Portugal’s problem ... is more economic and structural.”

As well as high personal debt and low savings, Portugal is also relatively uncompetitive compared with its European peers, increasing its need for external financing.

STRESS TESTS EYED

Diego Iscaro, an economist at IHS-Global Insight in London said that while the stable outlook was good news, investors should focus on how Portuguese banks will fare in the Europe-wide stress tests on major lenders due for publication later this month.

“I believe that any negative surprise there (stress tests) would have a larger impact than today’s downgrade,” he said.

On Monday, Treasury Secretary Carlos Pina told Reuters tests performed so far pointed to a “solid and robust” banking system without capital problems.

At 1300 GMT, shares in Portuguese banks were higher, though mostly lagging the European banking sector .SX7P.

Concluding a rating review started in May, Moody’s said it expected the Portuguese government’s debt metrics to worsen for at least two to three years, with the debt-to-GDP ratio “eventually approaching 90 percent.”

The agency said it remained concerned about the economy’s prospects, which were likely to remain relatively weak unless structural reforms bore fruit over the longer term.

The finance ministry said prioritizing fiscal consolidation might not guarantee a quick recovery but it was required for a sustained economic growth.

The government is aiming to cut the budget deficit to 7.3 percent of gross domestic product this year from last year’s 9.4 percent, and to 4.6 percent in 2011.

Additional reporting by Sergio Goncalves, Shrikesh Laxmidas, Filipa Lima and William James in London; editing by John Stonestreet

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