Moody’s, the ratings agency, on Monday downgraded Ireland’s government bond ratings because of the country’s deteriorating public finances.

The downgrade of one notch to Aa2 puts Moody’s rating on the same level as Standard & Poor’s, which rates Irish debt at AA, and one notch higher than Fitch, which gives the country’s bonds an AA minus rating.

Irish 10-year bond yields, which have an inverse relationship with prices, rose 8 basis points to 5.51 per cent, the highest level since the end of June. The cost to insure Irish debt against default rose by 10bp to 261. The country’s stock markets fell by about one per cent.

However, the euro and other European bond markets remained stable.

The action comes ahead of the planned auction of Irish government bonds on Tuesday when the country plans to issue €1.5bn ($1.9bn) in six-year and 10-year bonds. Ireland’s sovereign debt-issuing agency on Monday said it did not expect the downgrade to have an impact on the auction.

Analysts said the downgrade was not a surprise, given the country’s weak public finances and financial sector while Ireland’s National Treasury Management Agency said that the decision was “not unexpected”.

“We do welcome the fact that Moody’s has changed the outlook from negative to stable going forward. The rating decision is not based on any new information and we do not therefore expect it to have any impact in terms of our debt programme,” the NTMA said.

Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin, said there was no doubt that the NTMA would continue with its debt auction programme but that “early indications” were that the debt issuing agency would have to pay more at the auction.

Moody’s said the reason for the downgrade was the government’s gradual but significant loss of financial strength, as reflected by the substantial increase in the debt-to-GDP ratio and weakening debt affordability.

The ratings agency has also changed the outlook on the ratings of the government of Ireland from negative to stable as Moody’s now views the upside and downside risks as being evenly balanced at the current rating level.

Moody’s has also downgraded from Aa1 with negative outlook to Aa2 with stable outlook the rating of Ireland’s National Asset Management Agency (Nama), whose debt is fully and unconditionally guaranteed by the government of Ireland.

“Today’s downgrade is primarily driven by the Irish government’s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability,” says Dietmar Hornung, a Moody’s lead analyst for Ireland.

The country has suffered a dramatic contraction in GDP since 2008, causing a sharp decline in tax revenue. The general government debt-to-GDP ratio rose from 25 per cent before the crisis to 64 per cent by the end of 2009, and is continuing to grow.

Moody’s also expects economic growth to be below historical trend over the next three to five years for two reasons.

First, banking and real estate – the engines of Ireland’s growth in the years preceding the crisis – will not contribute meaningfully to overall growth in the coming years. Second, the fall in private sector credit is damping the growth outlook.

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