June 8 (Bloomberg) -- Ireland had its credit rating lowered for the second time this year by Standard & Poor’s, which cited the nation’s rising bill for propping up its banks.

The rating was cut one step to AA, from AA+, S&P said in a statement today, moving it to the same level as Japan, Slovenia and the United Arab Emirates. The rating company assigned a “negative” outlook to the grade, signaling it’s more likely to cut it again than leave it unchanged or raise it. S&P removed Ireland’s AAA rating in March this year.

“Ireland has many, many problems and we continue to view it as the weakest fiscal risk in the European Monetary Union, but investors should not leap to the view that this is an Iceland in disguise,” Harvinder Sian, a strategist at Royal Bank of Scotland Plc in London, wrote in a research note.

The difference in yield, or spread, between Irish and benchmark German 10-year government bonds rose three basis points in the wake of the rating change, climbing to 203 basis points. The spread jumped to 284 basis points on March 19, the most in 10 years, compared with an average of 22 basis points during the previous decade.

“The fiscal costs to the government of supporting the Irish banking system will be significantly higher than what we had expected when we last lowered the rating in March 2009,” David Beers, head of sovereign ratings at S&P in London, said in a statement. “Consequently, the net general government debt burden will also be significantly higher over the medium term.”

‘Not Inevitable’

A further downgrade of Ireland’s credit rating is “not inevitable,” Beers said on a conference call following the announcement.

Ireland’s economy is shrinking at the fastest pace among euro-area nations, curbing tax revenue at the same time as the government finances bank-rescue efforts. S&P said the cost of rescuing the banks may rise to as much as 25 billion euros ($34.6 billion), against its previous forecast of between 15 billion euros and 20 billion euros.

“The surprise is that S&P kept the negative outlook,” RBS’s Sian said in a telephone interview. “That means we could be looking at another cut, possibly within months, triggered by worsening asset quality at banks.”

Finance Minister Brian Lenihan is setting up a National Asset Management Agency to take on 90 billion euros of toxic property loans. The government has already pumped 7 billion euros into Allied Irish Banks Plc and Bank of Ireland Plc.

Government Strategy

The government has a strategy “to deal with the challenges,” Lenihan said in an e-mailed statement today. “I fully recognize that the NAMA process will of course have to be carefully implemented and considerable preparation work is therefore taking place,”

The cost of protecting Irish government debt increased after S&P downgraded the country. Credit-default swaps climbed 7.5 basis points to 222 basis points, according to CMA DataVision prices.

Credit-default swaps conceived to protect investors from default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase signals a deterioration in the perception of credit quality.

“Concern about the health of the economy and financial sector are going to be with us for some considerable time,” said Austin Hughes, chief economist with KBC Bank Ireland in Dublin. “It’s understandable that people are seeing the risks still skewed this way but perhaps we are a little bit past the worst.”

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Last Updated: June 8, 2009 08:49 EDT