Portugal's recession deepened in the fourth quarter of 2011, data showed on Tuesday, and the economy is set to slump further this year as the country, seen as the weakest euro zone link after Greece, implements more austerity under an EU/IMF bailout.

Moody's Investor Service cut Portugal's credit rating further into junk territory late on Monday, citing a weak economic outlook across Europe, which could cause a deeper and longer economic contraction in Portugal than previously anticipated.

Portuguese gross domestic product shrank 1.3 percent in the final quarter of 2011, more than double the previous quarter's 0.6 contraction, according to a flash estimate from the National Statistics Institute (INE). The data was slightly better than a 1.5 percent decline forecast in a Reuters poll but marked the fastest decline since the first quarter of 2009.

Mired in its worst recession since the 1970s and with unemployment at record highs, Portugal has come under the scrutiny of financial markets in recent weeks on concerns that it could follow Greece in seeking more rescue funds, or even need to restructure its debts.

Moody's said it expects the Portuguese economy to contract by more than 3 percent this year given the multitude of downside risks from the region ... as well as the immediate impact of the government's austerity measures.

Compared with a year earlier, GDP fell 2.7 percent in the fourth quarter, after a 1.8 percent decline in the previous three months.

Debt-laden Portugal has hiked taxes, slashed spending and resorted to pay cuts to meet tough fiscal goals under its 78-billion-euro bailout, which has hurt consumption and investment. Many of the measures were only effective from January and their impact is yet to show on the economic data.

Paula Carvalho, an economist at Banco BPI in Lisbon said the economic pattern of falling internal demand only partially compensated by growing exports was likely to continue at least through the first half of the year, which could make the government's budget consolidation plans more daunting.

We expect a 3 percent contraction this year, which means that there is the possibility of additional consolidation measures being needed. This will depend on how the budget execution goes, she said.

The government has to meet a budget deficit target of 4.5 percent this year. It met last year's 5.9 percent target, but only thanks to a one-off transfer of 6 billion euros from banks' pension funds to state coffers.

Tuesday's data showed the economy contracted by 1.5 percent last year, largely in line with the government's forecast of 1.6 percent. In 2010, the economy grew 1.4 percent. This year the government expects a contraction of around 3 percent as more austerity kicks in.

Portugal's benchmark 10-year bond yield was little changed from Monday's settlement level at around 12.1 percent on Tuesday. The yield has rolled back from a record high of more than 17 percent reached two weeks ago when concerns that the country would need a new bailout reached a peak.

The government has repeatedly ruled out the need for a second bailout.

(Additional reporting by Sergio Goncalves; Editing by Susan Fenton)