By Padraic Halpin
DUBLIN (Reuters) - Moody's cut Ireland's sovereign rating by two notches to the verge of junk status on Friday and kept its outlook on negative, pushing the euro lower and adding to renewed pressure on the euro zone's weaker countries.
The move sent Ireland's borrowing costs up and cut short a rare spell of good news after the government said on Thursday it had passed a review of its economic progress by creditors and ratings agency Fitch upgraded its outlook.
A soaring of Greek borrowing costs to new highs has turned up the heat on fellow strugglers Ireland and Portugal this week after Germany said for the first time that Athens may have to restructure its huge public debt.
Moody's official Dietmar Hornung told Reuters, however, that the chances of Ireland having to restructure any of its debt were very remote and said he expected Dublin's debt-to-GDP ratio to level off at a "sustainable" 120 percent.
An advisor to Greece's Prime Minister said last week that its debt-to-GDP will jump to over 150 percent by the end of the year, and higher still by the end of 2012.
However Moody's said Ireland's growing debt would be high by EU standards and that weak economic growth prospects together with the expected decline of the government's financial strength threatened its ability to manage the burden.
"Should the intended fiscal consolidation goals not be met, a further rating downgrade would likely follow," Moody's said. "Moreover, a further deterioration in the country's economic outlook would also exert downward pressure on the rating."
Moody's said the downgrade to BAA3 from BAA1 -- which puts its rating two notches below both Fitch and Standard and Poor's -- was also due to uncertainty around solvency tests required by the European Stabilization Mechanism (ESM)
It said the country may need to take further austerity measures to meet its fiscal goals and that its financial position may suffer as a result of rises in European Central Bank interest rates.
One in ten Irish mortgages were either in arrears or restructured at the end of 2010 and more customers are set to fall into difficulty after the ECB raised its base rate earlier this month.
The ratings cut pushed the euro to a session low against the dollar, falling as low as $1.4451, down 0.2 percent on the day, and moving further away from its 15-month high around $1.4521 hit earlier this week.
The Irish/German 5-year government bond yield spread was 20 basis points wider on the day at 724 bps. The equivalent 10-year spreads, which narrowed by around 100 basis points after an end-March fresh round of bank stress tests, were little changed on the day.
ALL ABOUT GROWTH
Ireland has been struggling to convince markets its spluttering economy can grow fast enough to sustain its debt burden since the International Monetary Fund and European Union arranged an 85 billion euros bailout last year.
The IMF this week slashed its forecast for Gross Domestic Product (GDP) growth to 0.5 percent from 0.9 percent previously and said it did not expect Ireland to meet the target of getting its budget deficit under an EU limit of three percent by 2015.
The government, which will get a full update on its progress on the IMF/EU deal later on Friday, is updating its forecasts but currently predicts 1.7 percent growth this year to give it a budget deficit of 9.4 percent.
Analysts said the Irish story would now be all about growth.
"It's absolutely all about growth now. I think we've parked the banking issue which is a positive and you can get that from the readings of the ratings agencies views."
On a positive note, Moody's said that upward pressures could also develop on Ireland's rating and that the country's long-term potential growth prospects remain higher than those of many other advanced nations.
(Editing by Patrick Graham)