Moody's credit rating agency warned Ireland on Friday it was in danger of losing its prized AAA sovereign debt rating if public finances were badly hit by banking sector woes and a worsening recession. The negative outlook echoes a similar warning from Standard & Poor's earlier this month and puts further pressure on Dublin to secure 2 billion euros ($2.57 billion) worth of spending cuts in talks with unions this week.
Prime Minister Brian Cowen, under fire for his handling of the economic crisis, wants Ireland to avoid the fate of fellow euro zone members Greece, Spain and Portugal which have all seen their ratings cut by S&P amid buckling public finances. Alan McQuaid, chief economist at Bloxham Stockbrokers, said Moody's comments further raised the pressure on the government to cut spending.
"This really turns up the pressure - if they don't deliver something very convincing next week they're going to be in serious trouble with the ratings agencies," McQuaid said. Moody's said Ireland, which is facing a budget deficit of 9.5 percent of GDP this year even with its targeted 2 billion euros worth of savings, had some room to manoeuvre due to its relatively low level of government debt.
Analyst Dietmar Hornung warned that Ireland's guarantee of all bank liabilities was a significant risk and the imploding housing market pointed to further pain ahead. "The sizeable indebtedness of households points to a particularly painful de-leveraging process," Hornung said in a statement.
Underlining how far sentiment towards the former "Celtic Tiger" economy has fallen, credit monitor CMA DataVision said on Friday that investors now view Ireland as the riskiest issuer of government debt in the euro zone.
Irish 5-year credit default swaps hit 262.6 basis points on Friday, indicating a cumulative probability of default of 20.6 percent, according to CMA. Greece was previously seen as the riskiest euro zone debt issuer. The yield spread of 10-yr Irish bonds over core German Bunds - another measurement of risk - widened to 228 basis points on Friday following Moody's statement, a session high.
"This is the first negative ratings action Moody's have taken on a euro zone sovereign for years, although they did previously take Belgium off positive outlook," said Ciaran O'Hagan, strategist at Societe Generale in London.
Moody's view is that a sovereign's willingness and ability to bail out a bank will often exceed its willingness to pay its own debts. This is because the macroeconomic consequences of a systemic banking crisis will generally exceed the impact of a domestic bond default. "In the case of highly exposed countries like Ireland and Belgium, this effectively is serious," said O'Hagan.