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S&P cuts Spain's rating due to weak growth outlook

Agency expects GDP to rise by only 1 percent next year

Standard & Poor's Ratings Services has lowered Spain's sovereign debt rating by a notch, citing the country's uncertain growth prospects, rising funding costs and a deterioration in the quality of the financial system's assets.

In a statement released late Thursday, S&P said the long-term rating was lowered to AA- from AA. The outlook on the rating is negative, implying the possibility of further downgrades.

Fitch last week also cut Spain's debt rating by two notches to AA-. Moody's Investors Service has placed its Aa2 rating for Spain on review for possible downgrade.

"Despite signs of resilience in economic performance during 2011, we see heightened risks to Spain's growth prospects due to high unemployment, tighter financial conditions, the still high level of private sector debt, and the likely economic slowdown in Spain's main trading partners," S&P said.

The impact of the downgrade on Spain's risk premium was relatively muted, with the spread between the Spanish benchmark 10-year government bond and the German equivalent holding just above 300 basis points. The stock market was also steady. The Spanish Treasury said the downgrade was the result of a "short-term analysis that suggests Spain is particularly vulnerable to turbulence" in the euro-zone financial markets. It said the ratings agency is under-estimating the reach of structural reforms put in place by the government.

S&P estimated Spain's economy would grow by only 0.8 percent this year, accelerating slightly to 1.0 percent in 2012, down from a previous forecast of 1.5 percent.

It expects unemployment to remain high at 20-21 percent this year and the next, which will place a drag on consumer spending. While noting the government had introduced some reforms to the labor market, S&P said "their impact on reducing labor market rigidities remains to be seen."

It also expects more subdued demand for Spanish exports, which have helped underpin the economy as domestic demand contracts.

S&P said it expects Spain's budget deficit this year to come in at 6.2 percent of GDP, largely in line with the government's target of 6 percent, down from 9.1 percent last year. This is expected to be the result of a better-than-expected performance by the central government offset by "budgetary slippages" at the municipal and regional levels. However, it said further measures will be needed to hit next year's target of 4.4 percent of GDP.

The agency said it may lower Spain's ratings again under a downside scenario in which the economy slips back into recession next year, with GDP contracting 0.5 percent, followed by a weak recovery.