Germany risks being sucked into Europe's debt crisis after Moody's Investors Service cut the country's credit outlook just hours before key data showed manufacturing output was stalling.
The ratings agency pegged back Germany's creditworthiness to negative from stable amid fears the turmoil in the euro zone is spiralling out of control.
Already Greece, Ireland and Portugal have needed multibillion-euro rescue packages from the European Union and IMF to stay afloat.
As the contagion has spread, borrowing costs for Spain have soared, forcing Madrid to ask for a €100 billion (Dh444.12bn) from the single-currency's bailout fund to prop up its battered banks.
Now Moody's has warned Greece's mounting debt problems are threatening the entire euro-zone project.
"The material risk of a Greek exit from the euro area exposes core countries such as Germany to a risk of shock that is not commensurate with a stable outlook," said the agency. "[It] would set off a chain of financial sector shocks ... that policymakers could only contain at a very high cost."
For Germany, the powerhouse economy in Europe, that would mean picking up most of the bill.
"The continued deterioration in Spain's macro-economic and funding environment [borrowing costs] has increased the risk that they will require some kind of external support," said Moody's.
To underline the problems facing Germany, factory output fell at its fastest pace in three years this month, data showed yesterday, exposing the vulnerability of the country to the turmoil rocking the single currency.
"The German manufacturing sector has been one of the key elements of the euro-zone recovery and to see it contracting at this rate is really quite worrying," said Chris Williamson, the chief economist at Markit, which compiles a purchasing managers' index.
Germany's reading was 43.3 points, a 37-month low and well below the 50-point mark separating contraction from growth. The data also indicated the private sector across the euro zone contracted for a sixth straight month, with a reading of 46.4.
The rate of decline in the euro-zone's peripheral economies was among the highest seen since the middle of 2009, said Mr Williamson.
Capital Economics said the data pointed to a contraction of 1 per cent of GDP this year, with worse to come next year.
"Against this backdrop, it appears inevitable that the debt crisis will deepen and that fears of some form of euro-zone break-up will intensify," said Ben May, the European economist at Capital Economics.
The data triggered a renewed downward swing in equities. The FTSEurofirst 300 index of top European stocks was down 0.08 per cent at 1,023.48 points in afternoon trading. The euro fell to about US$1.2104. Yields on Spanish five-year government bonds jumped above those on 10-year yields for the first time since June 2001.
Speculation remains the €100bn rescue of Spain's banks may be a precursor for a sovereign bail out, which could be as high as €300bn, according to analysts.
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