Fitch slashes Spain rating by three notches to 'BBB'

New rating is Spain's lowest among 3 main ratings agencies, leaves it just two short of junk status

Spain's credit rating was slashed by three notches on Thursday by Fitch, which signalled it could make further cuts as the cost of restructuring the country's troubled banking system spiralled and Greece's crisis deepened.

Fitch cut its rating on Spain's government debt by three notches to BBB and placed the country on 'negative outlook', meaning a further downgrade could come in coming months.

The new rating was Spain's lowest among the three main ratings agencies, and leaves it just two short of junk status, which would force many institutional investors to automatically dump Spanish assets.

"The negative outlook primarily reflects the risks associated with a further worsening of the euro zone crisis, notably contagion from the ongoing Greek crisis," the agency said in a release accompanying the downgrade.

Fitch said the rating downgrade reflected higher than expected recapitalisation needs for Spanish banks, which it said would be around 60 billion euros, or as high as 100 billion euros under a more severe stress scenario.

The country's rating also assumed the country would receive European help in recapitalising its banking system. Fitch said recapitalisation costs would push the country's debt to gross domestic product ratio up by 6 percentage points more than expected, and the ratio would peak at 95% in 2015.

Fitch acted without waiting for a widely expected EU rescue. Chancellor Angela Merkel said Europe was ready to act to ensure stability in the euro zone.

Spanish Prime Minister Mariano Rajoy said he would wait for the results of independent audits of the banking system before talking with Europe about how to recapitalise troubled lenders.

An International Monetary Fund report due out next Monday is expected to show Spanish banks need at least 40 billion euros, financial sector sources said.

One analyst largely shrugged off the credit downgrade.

"Spain is obviously the largest part of the conversation right now but for their credit rating to be downgraded to triple-B is very much in line with expectations. The larger news will be if Germany is successful in finding a way to get money into Spanish banks," said Art Hogan, managing director of Lazard Capital Markets in New York.

The agency said the country's rating would remain under pressure as the country would remain in recession this year and next. Previously it had forecast a mild recovery in 2013.

According to Fitch, Spain also remained especially vulnerable to contagion from the ongoing crisis in Greece, which was reducing its financing flexibility.