Moody's stripped Ireland of its last AAA credit rating on Thursday and warned Prime Minister Brian Cowen he needed to inflict more fiscal pain on his recession-wracked country or risk a further costly downgrade.
Cowen has had to put Ireland on a five-year austerity diet after a debt-fuelled property binge transformed the former "Celtic Tiger" economy into one of the industrialised world's worst performers when the housing market crashed.
Moody's said the government's corrective actions and low debt levels before its economic meltdown meant that it needed to carry out only a moderate downgrade at this stage. But it cautioned that the downside risks outweighed the upside risks.
The agency, which cut Ireland's rating to 'Aa1', said it would be closely watching Cowen's attempts to squeeze 4 billion euros in savings in the next budget in December.
But Moody's signalled it would not follow rival Standard & Poors in a rapid round of downgrades. "A meaningful fiscal adjustment will require an additional structural improvement of Ireland's primary budget balance," said Dietmar Hornung, Moody's senior analyst.
"But at this juncture I don't see imminent issues that would force us to change the rating in the short term," Hornung said in an interview with Reuters.
The loss of the AAA altogether was expected after Standard & Poor's cut its rating twice this year to AA, while Fitch downgraded Ireland by one notch to AA+ in April.
The euro hit the day's low against the dollar following Moody's action but the spread between Irish and German government bonds rose only slightly and the cost of protecting Irish government debt against default barely moved.
"We haven't been trading like an AAA country," said Rossa White, chief economist with Davy Stockbrokers. "I don't think it's going to affect the markets too much; our spreads are closer to where S&P have judged us."
CHALLENGES AHEAD
Ireland's finance ministry reiterated on Thursday that it was committed to cutting the budget deficit to under the EU limit of 3 percent of gross domestic product (GDP) by 2013 from a projected 10.75 percent this year.
But there are major challenges ahead.
After pushing through cuts amounting to 5 percent of GDP in 2009, largely via tax increases, Cowen needs to cut politically sensitive areas of spending, such as social welfare and public sector pay, to make further inroads.
His junior coalition partner, the Green Party, has already warned that another tough budget could make their partnership difficult and the popularity ratings of Cowen and his party are already at record lows.
But on the plus side, while the deficit is still rising, tax returns have started to come in on target and analysts said further evidence of that from the June exchequer figures, due out at 1530 GMT, would provide some support.
"In May, the data suggested that at least the tax receipts now were stabilising and the government had a fighting chance to hit their target, so if that is the case and the data supports that I think it will give people more comfort," said Dan McLaughlin, chief economist with Bank of Ireland.
McLaughlin said further clarity on the workings of Ireland's "bad bank" scheme to cleanse the banking sector of soured property assets would also soothe investor fears.
The National Asset Management Agency (NAMA) will significantly increase Ireland's national debt. A Reuters exclusive on Wednesday revealed that NAMA would not take ownership of the banks' loans until the middle of next year.
"There is uncertainty regarding the banking system but the setting up of NAMA is viewed by Moody's as a positive step," Hornung said.
