Ratings agency Moody's has cut its outlook for the European steel industry to negative and said it expects demand to weaken by up to 4 percent in the next 12 months, as the industry faces economic strain and weak construction and auto markets.

Weak developed markets, exacerbated by the euro zone debt crisis, and tight credit conditions in China -- the world's biggest steel consumer and producer -- have weighed on the sector, even if the costs of raw materials are falling.

U.S. and Asian producers have already forecast weak demand and prices stretching into the fourth quarter, when a pick-up might normally occur.

Even in a low- or no-growth scenario, the implications for the European steel industry are negative, given that the industry has only partly recovered from the dismal days of 2009, Moody's said in its report.

It forecast steel demand in the 27 countries in the European Union over the next year to range from a decline of four percent to growth of 2 percent, the upper range only if manufactured good exports remain strong.

The ratings agency said it expected steel producers to experience a material decline in profitability in the second half of 2011 and first half of 2012, compared with the first six months of the current year.  

Raw material prices would decline, it said, but less than steel prices -- squeezing margins. But the extent of the impact would depend on individual companies, Moody's added.

Generally speaking, we expect the companies' profitability (EBIT and EBITDA) in 2012 to be no worse than in 2010, as demand should be better and prices similar to 2010, it said.

Moody's said the pressure on European steel producers' ratings would depend on a number of issues including emerging market exposure and the duration of the slowdown, but said ArcelorMittal , ThyssenKrupp and Kloeckner were well positioned on liquidity.

ArcelorMittal, the world's largest steelmaker and the first of the Europeans to report, will publish third quarter results on Thursday.

Moody's had had the industry's outlook as stable since March 2010.