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Ireland disclosed a "horrendous" worst case price tag of over 50 billion euros ($68 billion US) on Thursday for bailing out its distressed banks and said it would have to make more drastic budget savings.
The euro dipped briefly against the U.S. dollar as markets contemplated Dublin's ever growing fiscal hole, but the
16-nation European currency soon recovered and investors reacted calmly overall, having largely priced in the latest bad news.
Elsewhere in the euro zone, Spain lost its final triple-A credit rating as Moody's cut it by one notch to Aa1, citing the budget impact of slower economic growth.
The downgrade had been widely anticipated after similar moves by Standard and Poor's and Fitch. Moody's said the outlook for Spain, which was to present a tough 2011 budget on Thursday with a much reduced borrowing requirement, was now stable.
Portugal -- the other euro zone nation in the markets' cross hairs -- announced new spending cuts and tax rises for next year late on Wednesday designed to reassure bond markets that have driven its borrowing costs to near record levels.
In a stark indicator of a two-speed economic recovery in the euro area, German unemployment fell to its lowest level in more than 18 years in September. The jobless rate was 7.5 percent compared to 20 percent in Spain.
Ireland's central bank estimated the ``stress case'' cost of winding down Anglo Irish Bank at 34 billion euros. Prime
Minister Brian Cowen's fragile government said it would have to inject another 2.7 billion euros into Irish Nationwide building society, on top of 2.7 billion already earmarked.
Finance Minister Brian Lenihan said the state would probably raise its stake to a majority in Allied Irish Banks, which needs an extra 3 billion euros in capital this year.
"We have to bring closure to this matter and that is what we have done today," Lenihan said. "Yes of course these figures are horrendous, but they can be managed over a 10-year period."
Dublin-based Davy Stockbrokers said the gross cost of restructuring the banks under a base scenario was now 46 billion euros, which would rise by 5 billion under the "stress case" for Anglo.
The "Celtic Tiger" that was once the EU's fastest-growing economy will be shackled by a public debt burden of nearly 99 percent of gross domestic product, which analyst Donal O'Mahony of Davy Capital Markets said would peak at 105 percent in 2012.
Lenihan said the level of state support for the banking system remained "manageable," even though it will push the 2010 deficit up to an unprecedented 32 percent of GDP -- more than 10 times the European Union's ceiling.
He said Dublin remained committed to reducing the deficit below the EU limit of 3 percent of GDP by 2014 and would outline a four-year budget plan in early November as sought by Brussels.
The premium investors demand to buy Spanish and Portuguese government bonds rather than benchmark Bunds fell while the Irish/German bond yield spread was unchanged from Wednesday's close at 466 bps.
Traders cited the fact that Moody's does not now expect to cut Spain's debt rating further and said a bill of up to 35 billion euros for Anglo Irish had been priced in.
PAIN IN SPAIN
In a sign of a healthier outlook for euro zone money markets, the European Central Bank doled out far less than predicted in six-day funds to banks, ensuring a bigger than expected drop in excess liquidity.
A copy of the Spanish budget, obtained by Reuters ahead of Thursday's parliament presentation, showed the government aims to cut its net debt issuance in 2011 to 43.3 billion euros from the 76.2 billion originally planned for 2010.
Economy Minister Elena Salgado announced a 7.9 percent reduction in public spending with cuts of an average 16 percent for government departments.
Under fierce pressure from investors who fear a possible Greek-style meltdown in the euro zone, fellow struggler Portugal announced fresh austerity measures for 2011 late on Wednesday.
Socialist Prime Minister Jose Socrates, who heads a shaky minority government, said civil service pay would be cut by 5 percent, public sector pensions would be frozen and value added tax would raised to 23 percent from 21 percent.
The Spanish downgrade illustrated the dilemma of peripheral euro zone governments that risk prolonging an economic slowdown with harsh measures required to reduce swollen budget deficits.
That could create a vicious circle of low growth and depressed revenue, making it harder to pay off public debt.
Trade unions staged strikes and demonstrations against austerity measures in several European Union countries on Wednesday, but analysts said the protests were too small and disparate to make governments change course.
The huge bill for Anglo was well above Dublin's previous official estimate of 25 billion euros but in line with a 35 billion euro worst case scenario by Standard's and Poor.
Lenihan said Ireland would have to slice more than the existing target of 3 billion euros off the 2011 budget but declined to say how much more. The additional cost of the bank rescue would be spread out over more than a decade.
The dawn announcement was meant to calm markets which drove the risk premium on Irish government bonds to a euro lifetime record of 475 basis points over German bonds on Tuesday.
"I think it's bold because what they are doing is really giving us the bad news upfront. I think the market needs to know and here it is," said Padraig Garvey, rate strategist at ING.
"It's a pretty astonishing deficit number, it's higher than the national debt a few years ago which is an incredible situation to be in," he said.
Lenihan said the Ireland, which is fully funded until June 2011, would cancel planned bond auctions in October and November and only return to the capital markets in 2011.