Fitch Ratings cut Spain's long-term credit rating to BBB and left it two notches from junk, citing the cost of recapitalizing the country's banking industry and a lengthening recession.

Spain, which saw its rating lowered from A, may need as much as 100 billion euros ($126 billion) to bolster its banking system, compared with an earlier estimate of about 30 billion euros, Fitch said today in London. The Spanish economy is set to remain in recession through 2013, the ratings company added, having previously forecast a recovery for next year.

“The much reduced financing flexibility of the Spanish government is constraining its ability to intervene decisively in the restructuring of the banking sector and has increased the likelihood of external financial support,” Fitch said in a statement. “Spain's high level of foreign indebtedness has rendered it especially vulnerable to contagion from the ongoing crisis in Greece.”

The government managed to auction 10-year debt today amid speculation that European officials will act to boost growth in the single currency area and ease the pressure on peripheral nations. Budget Minister Cristobal Montoro said June 5 that Spain was shut out of capital markets.

“The positive moves we have had this week have been on a strange logic that things have got so bad that the authorities need to do something about it,” said Elisabeth Afseth, an analyst at Investec Bank Plc in London. The cut isn't really a surprise “given where the spreads have been, Spain's potential difficulties and the fact they may have to seek support.”

Fitch's reduction by three levels now leaves its assessment of Europe's fourth-biggest economy on a par with Thailand and Mexico. Standard & Poor's has a BBB+ rating on Spain, while Moody's Investors Service grades it A3. Fitch cut the country from AAA in May 2010.

“It was inevitable,” said David Keeble, head of fixed-income strategy at Credit Agricole Corporate & Investment Bank in New York. “What really matters is the political will to sort things out. Quite clearly Spain is going to need external help.”

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Spain Downgraded to BBB by Fitch

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