The credit rating agency said the move had been prompted by the “repeated crystallisation of bank related contingent liabilities” which have hit the government’s balance sheet.

There was also increased uncertainty over the country’s economic outlook and the decline in the government’s financial strength.

Moody’s said the negative outlook reflected concerns that the government’s financial position could deteriorate “if economic growth were to be lower than currently projected or the costs of stabilising the banking system turn out to be higher than currently forecast”.

Moody’s took parallel action against the Irish government’s National Asset Management Agency, which issues government-backed bonds to Irish banks as it acquires their impaired property loans. Nama is downgraded five notches from Aa2 to Baa1.

Dietmar Hornung, senior credit officer at Moody’s, said the government was now committed to injecting about €50bn of capital into its banking sector, an amount equivalent to 32 per cent of gross domestic product. This includes the €10bn of capital being provided under the terms of the €85bn bail-out by the International Monetary Fund and Ireland’s European Union partners.

Moody’s said that in the weeks ahead of the bail-out announcement “the problems in the Irish banking sector once again became acute as confidence in and funding of Irish banks evaporated, in conjunction with the expiry of the original government guarantee” in September.

The agency said the €15bn of fiscal adjustment planned over the next four years “represents a further considerable drag on the country’s recovery prospects”.

It added: “Indeed, the EU has acknowledged Ireland’s uncertain economic outlook by extending by one year to 2015 the time frame within which the country has to achieve the 3 per cent general government budget deficit target.”

Mr Hornung said Moody’s “now expects Ireland’s debt ratio to increase to 120 per cent in 2013 from 66 per cent in 2009 before levelling off”.

When including the Nama debt, the ratio peaks at 140 per cent. Moody’s said the country would face a further downgrade “should Ireland’s adjustment capacity prove to be insufficient.”

Mr Hornung said the agency was “obviously monitoring the discussions” on the treatment of bank bond debt currently under way in the main opposition parties.

Fine Gael and Labour, who are likely to form the next Irish government after the election in the new year, have both said they want to renegotiate the terms of the EU-IMF bail out and are also committed to achieving greater burden sharing by bank bondholders.

But Mr Hornung said Moody’s was interested “in policy not politics” and noted that both parties were committed to the four year fiscal adjustment plan.

FT.com