MADRID (Bloomberg) - Spain's top credit rating was cut one level by Moody's Investors Service, which cited a "weak" economic outlook and doubts that the nation will reach deficit- reduction targets.

The ratings company lowered Spain to Aa1 from Aaa with a stable outlook, it said yesterday in a statement. Spain lost its top grade at Fitch Ratings in May and at Standard & Poor's in January 2009. Bonds rallied as some investors anticipated a two- grade cut. Moody's downgraded Greece by four steps in June and Portugal by two in July.

"It's a relief, as the market was pricing the worst possible outcome," said Gianluca Salford, a fixed-income strategist at JP Morgan Chase Bank in London. "When you look at how Moody's is treating the other peripherals, a one-notch cut was the most realistic option."

Spanish Deputy Finance Minister Jose Manuel Campa said in a telephone interview yesterday the cut was based on "overly pessimistic" growth estimates. Finance Minister Elena Salgado presented the most austere budget in three decades to Parliament yesterday. The plan includes a reduction in public wages, higher taxes and a pension freeze.

Moody's sees growth of about one percent per year on average over the "next few years", it said in the release. The Spanish government expects an expansion of 1.3 percent next year, accelerating to 2.5 percent in 2012 and to 2.7 percent in 2013.

"Long-term growth potential is slightly below two percent," Mr. Campa said yesterday.

Spain will sell 192 billion euros of debt in gross terms next year, according to the 2011 budget. Redemptions will amount to 148.7 billion euros, leaving net new borrowing of 43.3 billion euros, the budget showed. Outstanding debt increased by 76.1 billion in 2010, according to forecasts in the budget.

The extra yield investors charge to hold Spanish 10-year debt rather than the German equivalents narrowed to 188 basis points from 196 basis points on Wednesday. The spread reached 233 basis points on June 17, the widest since the start of the euro more than a decade ago.

Portuguese spreads narrowed to 410 basis points from 423 basis points on Wednesday after the government followed Spain's lead in its budget plan announced late yesterday, cutting wages, raising taxes and freezing investment.

Spain's budget, approved by the Cabinet on September 24, aims to reduce spending by three percent compared with this year and includes an increase in income tax for those earning more than 120,000 euros a year.