Standard & Poor's has lowered Spain's long-term credit rating by two notches, saying the country's budget problems are likely to get worse because of the weak economy.
The ratings agency reduced Spain's long-term sovereign credit rating to BBB+ from A and also lowered the country's short-term rating and assigned a negative outlook, which suggests the possibility of another downgrade in the near future.
Spain's credit rating is still in investment grade, three notches above junk status. Nonetheless, the lower rating could increase the nation's borrowing costs because investors will likely demand higher interest rates to compensate for the greater risk implied by the downgrade.
But it is nowhere near Greece, which was downgraded to default by the three major rating agencies after its private creditors were forced to take the biggest debt writedown in history.
The agencies - S&P, Moody's and Fitch - are expected to raise Greece's rating after it this week completed a huge bond exchange designed to more than halve its privately held debt.
S&P's downgrade of Spain, announced after the close of markets in the US, was not a total surprise. Moody's cut Spain's rating two notches in February due to the country's difficult fiscal outlook.
S&P cited the risk that Spain's government debt will expand as the contracting economy exacerbates the nation's budget woes. The Spanish central bank confirmed this week that Spain is in recession for the second time in three years. A jobless rate of nearly 23% is expected to rise. The agency also noted the "increasing likelihood" that the Spanish government will need to provide further help for the banking sector.
To go along with the credit downgrade, S&P lowered its forecast for Spain's economic outlook. The agency said it expects the economy to contract by 1.5% this year and 0.5% in 2013. Its previous outlook had growth of 0.3% in 2012 and 1% in 2013. Spain's new conservative government has forecast that the economy will contract 1.7% this year.
The agency said Spain's economy was "rebalancing" and the government's moves should help.
The government of prime minister Mariano Rajoy has pushed through deficit-reduction steps including labour market and financial sector measures.