Moody's Investor Service cut Portugal's debt rating by two notches to A1 on Tuesday citing rising debt and weak growth prospects, and said the country may need to come up with more austerity measures in its 2011 budget.
The move sent the euro lower, but broad market reaction was relatively muted as the cut only saw Moody's make up ground with rival agency Standard & Poor's, which still rates Portugal two grades lower at A-.
It doesn't have the same impact as it would if the likes of S&P were to downgrade, given the move only brings (Moody's) in line, said Sean Maloney, rate strategist at Nomura.
S&P cut Portugal by two notches in April.
Moody's said in a statement after a review that started in May it expected the government's debt metrics to continue to deteriorate for at least another two to three years, with the debt-to-GDP and debt-to-revenues ratios eventually approaching 90% and 210%, respectively.
Moody's also remains concerned about the economy's medium-term growth potential, it said.
Prospects were likely to remain relatively weak unless structural reforms bore fruit over the longer term, it added, explaining the downgrade.
Anthony Thomas, vice president of Moody's Sovereign Risk Group, told Reuters that Portugal remained in the high end of investment grade and Moody's outlook was now stable, which means there is no revision planned for at least 12 months.
Also, we think that upside risks offset downside risks such as an even weaker growth and interest rates remaining high, Thomas said, explaining that the upside risks involved mainly an even more aggressive consolidation.
He said that while the government's budget consolidation targets for this year looked credible, there is a strong pressure on the government to meet 2011 targets and we believe it will come up with more measures in the 2011 budget.
David Tinsley, economist at National Australia Bank, said: The downgrade is going to weigh on the euro in the short term and doesn't bode well ahead of the bank stress tests due next week.
(Reporting by Andrei Khalip; editing by John Stonestreet)