DUBLIN (Reuters) – Ireland disclosed a mammoth "final" price tag of nearly 40 billion euros ($54.33 billion) on Thursday for bailing out its distressed banks and said it would have to make more drastic budget savings.
As markets contemplated Dublin's ever growing fiscal hole, ratings agency Moody's cut Spain's AAA top-notch credit rating to Aa1, citing the budget impact of slower economic growth.
The downgrade was widely expected and followed similar moves by Standard's and Poor and Fitch.
Portugal -- the other euro zone nation in the markets' cross hairs -- announced late on Wednesday new austerity measures for 2011 designed to reassure bond markets that have driven its borrowing costs to near record levels.
Ireland's central bank estimated the worst case cost of winding down nationalized Anglo Irish Bank at 34 billion euros and Prime Minister Brian Cowen's battered government said it would have to inject 5.4 billion euros more in taxpayers' money into Irish Nationwide building society.
The euro slipped against the dollar as traders took stock of the impact on a country that was once the EU's fastest-growing economy but will now be shackled by a public debt burden of nearly 99 percent of gross domestic product.
But overall, financial markets reacted calmly, assuaged by the fact that Moody's does not now expect to cut Spain's debt rating further while traders said a bill of up to 35 billion euros for Anglo Irish had been priced in.
The premium investors demand to buy Spanish government bonds rather than euro zone benchmark Bunds actually fell while the Irish/German bond yield spread was unchanged versus Wednesday's settlement close at 466 bps.
A copy of the Spanish budget, obtained by Reuters, showed the government aims to cut its net debt issuance in 2011 to 43.3 billion euros from the 76.2 billion originally planned for 2010.
Economy Minister Elena Salgado will present the full budget for 2011, the bulk of which is already known, at 0940 GMT. On Friday, she announced cuts of 7.9 percent across public spending and cuts of an average 16 percent for government departments.
Finance Minister Brian Lenihan said the bill for Ireland's banking crisis was "horrendous" but it brought to a close the public's response to the disaster.
He said the state would also probably take a majority stake in Allied Irish Banks, which needs an extra 3 billion euros in capital by the end of the year.
The level of state support for the banking system remained "manageable," he said, even though it will push the 2010 deficit up to an unprecedented 32 percent of gross domestic product -- more than 10 times the European Union's ceiling.
The huge bill for Anglo was well above Dublin's previous official estimate of 25 billion euros but in line with a 35 billion euro worst case scenario by Standard's and Poor.
Lenihan said the government remained committed to reducing the deficit below the EU limit of 3 percent of GDP by 2014 and would outline a four-year budget plan in early November, something EU officials have pressed for.
"Today's announcements take the Irish banking system closer to a final resolution of its restructuring, which is a prerequisite for sustained economic recovery," Central Bank Governor Patrick Honohan said in statement.
Lenihan said Ireland would have to slice more than the existing target of 3 billion euros off the 2011 budget but declined to say how much more. The additional cost of the bank rescue would be spread out over more than a decade.
Under fierce pressure from investors who fear a possible Greek-style meltdown in the euro zone, fellow struggler Portugal announced fresh austerity measures for 2011 late on Wednesday.
Socialist Prime Minister Jose Socrates, who heads a shaky minority government, said civil service pay would be cut by 5 percent, public sector pensions would be frozen and value added tax would raised to 23 percent from 21 percent.
The Spanish downgrade illustrated the dilemma of peripheral euro zone governments that risk prolonging an economic slowdown by making the deep public spending cuts and tax rises required to reduce swollen budget deficits.
That could create a vicious circle of low growth and depressed revenue, making it harder to pay off public debt.
Trade unions staged strikes and demonstrations against austerity measures in several European Union countries on Wednesday, but analysts said the protests were too small and disparate to make governments change course on deficit cuts.
Ireland issued an unlimited guarantee for its banks in 2008 after a housing bubble burst and the global financial crisis threatened to bring down its financial sector.
The dawn announcement was meant to calm markets which drove the risk premium on Irish government bonds to a euro lifetime record of 475 basis points over German bonds on Tuesday.
"I think it's bold because what they are doing is really giving us the bad news upfront. I think the market needs to know and here it is," said Padraig Garvey, rate strategist at ING.
"It's a pretty astonishing deficit number, it's higher than the national debt a few years ago which is an incredible situation to be in," he said.
Lenihan said the Ireland, which is fully funded until June 2011, would cancel planned bond auctions in October and November and only return to the capital markets in 2011.
(additional reporting by Axel Bugge in Lisbon, Nigel Davies in Madrid, Andras Gergely and Padraic Halpin in Dublin; writing by Paul Taylor; editing by Mike Peacock)