THE TAKEAWAY: Moody’s downgrades Spain > Downgrade follows similar ratings action by S&P and Fitch > Euro falls

The Euro dropped over 25 pips after Moody’s downgraded Spain’s government debt by two notches on Tuesday. As of 22:00 GMT, the common currency was continuing its slide from an earlier rally in the wake of reports that European leaders would increase the firepower of the EFSF bailout fund.

Euro_Slides_Following_Spain_Downgrade_body_Picture_5.png, Euro Declines Following Spain Downgrade

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However, the Euro’s fall was tempered as Moody’s move follows similar rating action by other rating agencies over the past two weeks. Moody’s two-notch downgrade of Spain’s government debt ratings to A1 follows downgrades by S&P and Fitch, which lowered the country’s credit rating by one level and two levels, respectively, to AA-. All three agencies maintain a negative outlook on the rating.

In its rationale for the downgrade and negative outlook, Moody’s cited the absence of a solution for the European debt crisis and the worsening economic outlook for Spain. The agency lowered its forecast of 2012 GDP growth from 1.8 percent to 1 percent on continued softness in the labor market and “the difficult funding situation for the banking sector.” While acknowledging Madrid’s efforts to reform the labor market and introduce a balanced-budget constitutional amendment, Moody’s expressed “serious concerns” about regional government deficits and voiced doubt about the general government sector’s ability to meet “ambitious” fiscal targets.

While still lower than the high of 6.28 percent reached on August 4, yields on Spain’s 10-year government bonds have been in an upward trajectory since the start of October; the yield was up 23 basis points month-to-date to 5.37 percent as of Tuesday. Five-year credit-default swap spreads on Spanish sovereign debt are trading at 523 bps on Tuesday, up from 501 at the start of October.

For the remainder of the week, the Euro will continue to be impacted by statements from Europe in anticipation of a summit of EU leaders on Oct. 23. The currency had rallied earlier on a report in the UK’s Guardian newspaper stating that Germany and France had agreed to raise the EFSF to 2 trillion Euros. Further developments in the lead-up to the summit will continue to influence the direction of the common currency.