Ireland Credit Rating Cut One Step by S&P on Rescue (Update2)

By John Fraher and Dara Doyle
Aug. 25 (Bloomberg) -- Ireland’s credit rating was cut one step by Standard & Poor’s to AA-, the lowest since 1995, on concern the rising cost of supporting the country’s struggling banks will swell the budget deficit.
S&P raised its estimate for recapitalizing the banking system to as much as 50 billion euros ($63 billion) from a previous estimate of as much as 35 billion euros. Ireland’s rating is still one notch better than Italy and three above Portugal. It is seven steps higher than Greece’s junk status.
“A further downgrade is possible if the fiscal cost of supporting the banking sector rises further,” S&P said in a statement yesterday. Ireland is slated to sell between 400 million euros and 600 million euros worth of bills tomorrow.
Irish Prime Minister Brian Cowen is trying to convince investors the country can cap the cost of rescuing a banking system that almost collapsed after the worst recession on record. The S&P cut comes three months after the European Union announced a rescue package for nations stung by the Greek fiscal crisis and as the slowing global economy prompts traders to dash for the safety of U.S. Treasuries and German bunds.
“They’re going to pay very high yields for a prolonged period of time,” Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington, said in an interview. While “this isn’t Greece,” the “misfortune for Ireland is not only have they had an incredible housing bust, they have also had very poorly regulated banks.
That sets them quite apart” from a country such as Spain.

‘Flawed’

The yield on Irish 10-year government bonds rose 6 basis points to 5.314 percent as of 8:12 a.m. in London. The extra yield demanded by investors to hold the debt over German counterparts climbed to a record of 321 basis points, 15 points higher than their level before a EU-led rescue plan for the euro region was announced on May 10. The Spanish and Greek spreads were at 184 points and 884 points, respectively.
Irish debt is now riskier than that of Iceland, whose financial system fell apart in 2008. Credit-default swaps on its bonds have surged nearly 200 basis points since March to 309 basis points, the highest since March 2009, according to data provider CMA.

Bailout Limit

Ireland’s debt agency said in a statement that S&P’s analysis is “flawed” and that its decision was based on an “extreme” estimate of bank recapitalization needs. It also said that the country is fully funded into the second quarter of 2011. A spokesman for the finance ministry said Ireland still plans to cut its budget deficit to below the EU’s limit of 3 percent of gross domestic product by the end of 2014.
Irish spreads have surged this month as investors fret the government won’t be able to limit the cost of bailing out the banks to its estimated 30 billion euros. The European Commission on Aug. 10 approved an additional injection of about 1.4 billion euros into Anglo Irish Bank, which was nationalized last year as bad debts jumped.
That triggered concern that the overall costs of rescuing the bank are rising at a time when unemployment is still rising and tax income is under threat.
S&P said its new projections suggest that Ireland’s net general government debt will rise toward 113 percent of gross domestic product in 2012. That’s more than 1.5 times the median for the average of euro zone sovereign nations and “well above” the debt burdens the New York-based firm projects for similarly rated countries such as Belgium and Spain. Those countries have debt-to-GDP ratios of 98 percent and 65 percent, respectively.

ECB Plan

The spreads on Spanish and Irish bonds have risen above the levels touched in May, when the Greek fiscal crisis prompted the European Central Bank to buy government bonds for the first time. ECB council member Axel Weber signaled in an interview on Aug. 19 that he’s relaxed with current yields, saying that the bond purchase program was designed to smooth tensions in bond markets rather than set a floor to prices.
Irish counterpart Patrick Honohan said a day later that the Anglo Irish issue must be resolved because of the impact it is having on investors. Supporting the bank may result in a net cost of about 22 billion euros to 25 billion euros to the Irish government, he said.
“This is a matter which will need to be finally put to rest very soon,” Honohan said in Tokyo. “The uncertainty around it is having a disproportionate impact on international investors.”