The credit ratings agency Standard and Poor's has downgraded Spanish sovereign debt, cutting it from A to BBB+. The country's outlook remains negative, indicating that the ratings agency expects the possibility of further trouble in the future.

The reason given was worse than expected economic contraction:

We have lowered our forecast for GDP to contract in real terms by 1.5 per cent in 2012 and 0.5 per cent for 2013. We had previously forecast real GDP growth of 0.3 per cent in 2012 and 1 per cent in 2013. . .

Following budgetary slippage of 2.5% of GDP in 2011 beyond the 6.0% target, the government has committed to a target of 5.3% of GDP in 2012 and 3.0% in 2013. In our opinion, these targets are currently unlikely to be met given the economic and financial environment.

In other words, S&P expect Spain to remain in recession throughout 2012 and 2013, and also think that the governing People's Party won't be able to enact their proposed austerity program.

The news is bad for the Spainish government, which has seen its bond yield rise to 6 per cent since the the downgrade was announced. If the nation really does return to recession and fail to cut spending as a result, that will be much more expensive as a result of this increased cost of borrowing.

But the news also hits hard at austerity advocates. Spain has been a poster child for fiscal responsibility, running a budget surplus before the financial crisis, and cutting its deficit from levels comparable with the UK and US in 2009 to far below in just two years, as this chart via Pawel Morski shows:

If textbook austerity cannot save Spain from being downgraded, then proponents of the ideology – who often point to the need to keep bond markets, and by extention ratings agencies, happy – may have to rethink their defence. Despite warning of a further downgrade if debt breaches 80 per cent of GDP, in their reasoning for this one, Standard and Poor's appear to be saying that growth matters more than fiscal responsiblity, because without the former, the latter cannot occur. While that is hardly a controversial claim, it comes from a surprising source, and it will be interesting to see their response the first time a nation takes them at their word.