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Spanish Credit Rating Set for Moody’s Cut as Growth Slows

Spain’s top Aaa credit rating, held since 2001, probably will be cut one level by Moody’s Investors Service as the euro region’s fourth-biggest economy struggles to grow, according to investors managing about $700 billion.

Five out of eight money managers surveyed predicted a one- step reduction to Aa1, with the rest forecasting a two-level cut to Aa2. The decision may come this week after Moody’s put Spain’s debt on review for a possible downgrade on June 30, saying it would conclude the analysis within three months.

Moody’s said then it will take several years for Spain’s economy to recover from the collapse of its real estate boom, predicting gross domestic product will expand an average of “slightly above” 1 percent between 2010 and 2014. A one-step cut would put Moody’s ranking on par with Fitch Ratings, which has a AA+ classification for the Iberian nation, while a two- level reduction would equal Standard & Poor’s.

“The market is pretty shaky so if they get downgraded by two, then that could have an impact,” said Andrew Balls, London-based head of European portfolio management at Pacific Investment Management Co., which runs the world’s biggest bond fund. “We keep an eye on what rating agencies do, sometimes as a lagging indicator, as something that can be important in terms of market sentiment.”

Yields Decline

Spanish borrowing costs have declined since the Moody’s announcement, with the yield on the 10-year bond falling to 4.21 percent yesterday in Madrid from 4.56 percent at the end of June, as stress tests in July showed the nation’s banks needed less than 1.8 billion euros ($2.5 billion) in new capital. Yields also dropped as the government of Prime Minister Jose Luis Rodriguez Zapatero implemented austerity measures to trim the budget deficit.

Spain’s central government budget deficit narrowed by 42 percent in the first eight months of the year as tax revenue surged and spending cuts took effect. The shortfall fell to 3.3 percent of gross domestic product from 5.7 percent a year earlier, the Finance Ministry said two days ago.

Bonds of so-called peripheral euro-region nations plunged this year as a debt crisis that started in Greece spread to other nations, prompting the European Union and International Monetary Fund to put in place a $1 trillion financial backstop for its members. Yields on Ireland’s 10-year bonds rose to a record relative to benchmark German bunds yesterday on concern the nation’s banks may need additional funding. The Portuguese- German bond spread also reached a euro-era high.

‘Deteriorating’ Prospects

S&P said yesterday that Ireland’s bailout of Anglo Irish Bank Corp. may cost more than 35 billion euros, exceeding its previous estimate. Moody’s downgraded the senior debt of Anglo Irish on Sept. 27 to the lowest investment grade and said it may cut it to junk unless the government guarantees bondholders against losses.

Moody’s cited Spain’s “deteriorating” growth prospects in June, the challenge of implementing spending cuts and increasing borrowing costs. The nation is likely to lose its top credit rating, Steven A. Hess, senior credit officer at Moody’s said on July 30.

Spain grew just 0.2 percent in the second quarter and 0.1 percent in the first three months of the year as unemployment stayed above 20 percent, the highest in the euro-region. The economy will shrink 0.4 percent this year, before growing 0.5 percent in 2011 and 1.4 percent the following year, according to the median of as many as 23 economist estimates compiled by Bloomberg.

Spanish debt may have a muted response to a downgrade, because Moody’s has signaled its intentions ahead of time, said Toby Nangle, director of asset allocation at Baring Asset Management in London.

‘Well Flagged’

“When a downgrade is really well flagged, about 80 percent of the price action tends to come through before the decision,” said Nangle, who doesn’t hold any Spanish debt. “After the announcement another 20 percent occurs.”

Concern about Spain’s banking system eased this month as the nation’s lenders reduced their reliance on the European Central Bank. They cut borrowing to 3.5 percent of assets in August from 4.1 percent a month earlier, according to ING Groep NV. Irish banks increased liabilities to 5.7 percent of assets from 5.4 percent, while Portuguese banks stayed at 8.8 percent, ING figures showed.

Zapatero faces a general strike today as unions protest the government’s spending cuts and changes to labor rules. Finance Minister Elena Salgado presents the nation’s budget to parliament tomorrow. The ruling Socialists don’t have a majority and are negotiating for support of its spending plan.

“Spain has been trading like AA debt for a while,” said Robin Marshall, who oversees about $20 billion of fixed-income investments at Smith & Williamson Investment Management in London, and who added to his holdings of Spanish debt last week. “The market has got it right on Spain so far, gravitating it toward Italy and away from Ireland and Portugal.”