Moody's warns of worse to come as it cuts Portugal rating

Portugal was dealt a blow yesterday as Moody's cut its credit rating, warning the economy would weaken further in the next few years.

The agency announced it had downgraded Portugal two notches from AA2 to A1, a move that increases the cost of its borrowing, as well as an indication that a default could be more likely.

Peter Dixon, a senior analyst at Commerzbank, said: "Portugal is between a rock and a hard place; it has serious structural and fiscal issues that need tackling."

He added: "The problems have been there since Portugal joined the Economic and Monetary Union. It wasn't strictly contagion, but Greece highlighted the problem."

Portugal's budget deficit hit 9.3 per cent of gross domestic product last year with only Ireland, Greece and Spain worse in the eurozone. This prompted the prime minister, Jose Socrates, to introduce an austerity plan. He said recently that the move had begun to pay off over the past six months.

Yet the Moody's analyst Anthony Thomas said the deterioration of the country's debt-to-GDP and debt-to-revenues ratios meant "the Portuguese government's financial strength will continue to weaken over the medium term". It added that the country's economic growth prospects "are likely to remain relatively weak unless recent structural reforms bear fruit over the medium to longer term".

Moody's announcement comes just weeks after revealing it was considering a downgrade of Spain's credit rating. Mr Dixon said: "Portugal is in a tougher position to Spain as it does not have the export resources to dig itself out of a hole."

While the euro wobbled, the move to cut Portugal's rating was not met with a disastrous reaction in the market as it brought the rating closer to Standard & Poor's, which cut Portugal's rating in April.

Yesterday, the Bank of Portugal also heavily cut its growth estimate for 2011 to 0.2 per cent down from 0.8 per cent. The central bank warned that the country could fall back into recession following a slowdown in the second half.