MADRID (Reuters) – Moody’s downgraded Spain’s sovereign debt rating by one notch on Thursday and warned of further cuts to come due to fears that bank restructuring will cost more than twice what the government expects.

“(Moody’s) believes there is a meaningful risk that the eventual cost of the recapitalization effort could considerably exceed the government’s current projections,” the ratings agency said in a statement.

The cut in the rating — to Aa2 from Aa1 — drove the euro to session lows against the dollar and the premium investors charge for Spanish 10-year debt instead of German Bunds widened 9 basis points on the day to 232 bps.

The Bank of Spain will release its own report on banks’ capital needs after markets close on Thursday.

The government and central bank have forecast no more than 20 billion euros would be needed to recapitalize weak banks.

But Moody’s said the overall cost was likely to be nearer 40-50 billion euros. In a more stressed scenario recapitalization needs could even rise to around 110-120 billion euros, it said.

Moody’s still rates Spain as a high grade investment proposition. By way of comparison, the agency rates Portugal two notches lower and Greece far down with junk status.

Spanish sovereign debt prices had stabilized recently after months of volatility, as investors became less concerned that Spain could follow Greece and Ireland in needing a financial bailout from the European Union.

A bank bill at the higher end of forecasts could change that.

“I think there are a lot of uncertainties about the bank shortfall, but given the cost of bailouts in countries like Ireland, the forecast given by the government looks low,” said Ben May, economist at Capital Economics.

European shares slid as the downgrade raised concerns about the health of peripheral euro zone economies. The FTSEurofirst 300 index of top European shares was down 0.72 percent at 1,136.55 points.

GOVERNMENT SURPRISED

“We are surprised that Moody’s has taken this decision before knowing the details of the (Bank of Spain’s) report on the recapitalization of the Spanish financial sector,” Spanish Treasury Director Soledad Nunez told Reuters.

She said Moody’s had had until March 15 to take its final decision after putting Spain on credit watch on Dec 15.

The Moody’s rating is now in line with the Standard & Poor’s rating of AA. The other major ratings agency, Fitch, has a rating one notch higher, AA+, but last Friday revised its outlook on Spain to negative.