Irish Downgrade

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S&P cut Ireland's credit rating. It nows stands at AA and, with a negative outlook, the risk is another downgrade. The debt-to-GDP ratio is approaching 100% and compared with the low 40% area before the crisis began. S&P cut its triple A rating in March and Ireland's new AA rating is the same as Japan's. The immediate reaction was to take the euro lower, which in any event was trading heavility, and the 10-year spread between Ireland and Germany widened 3-4 bp. It had closed near 200 bp before the weekend.

Ireland's economy is the weakest with the eurozone. The economy contracted in three quarters in '08 having eked out a small gain in Q3 before slumping 7.5% in Q4. Q1 GDP is not due out until late in the month, but another sizeable decline is expected.

The governing party was crushed in the local and EU parliamentary elections. It faces a vote of confidence tomorrow. Last week's opinion polls and electoral outcome suggest the government's support is shaky. It may be close, but on balance, PM Cowen is expected to survive. Yet if he doesn't, it is probably worth a few knee jerk losses in the euro.

However, Ireland is in an especially difficult place. The cost of the financial bailout, coupled with the loss of tax revenue due to the severe contraction and counter-cyclical spending is proving to be overwhelming. Ireland is not only being squeezed from within the eurozone, where its unit labor costs have risen sharply compared to Germany, and outside the eurozone from the sharp depreciation of sterling on a trade-weighted basis.