Moody's cuts Spain's debt rating

Rating agency Moody's has downgraded Spain's sovereign debt rating by one notch and warned of further cuts to come.

The cut in the rating – to Aa2 from Aa1 – drove the euro to session lows against the dollar, while the premium investors charge for Spanish ten-year debt instead of German Bunds expanded to its widest point in two months at 232 basis points before narrowing again to 226.

Moody's added that it was concerned that bank restructuring will cost more than twice what the government expects.

"(Moody's) believes there is a meaningful risk that the eventual cost of the recapitalisation effort could considerably exceed the government's current projections," it said in a statement.

Kathleen Brooks, research director for forex.com, said the timing of the announcement shocked the market and “caused a large knee-jerk reaction with the euro sold across the board.”

But she said it reassured as well.

“The crucial point to note in Moody’s announcement is that it does not think that Spain’s debt burden is unsustainable and thus it is optimistic that Spain will avoid the need for a bailout,” she said.

The Bank of Spain will release its own report on banks' capital needs after markets close.

The government and central bank have forecast no more than €20bn (£17.2bn) would be needed to recapitalise weak banks.

But Moody's said the overall cost was likely to be nearer €40-50bn. In a more stressed scenario recapitalisation needs could even rise to around €110-120bn, it said.