Spain downgraded over spiralling recession

It also said further downgrades may come down the line, as Spain's economy is expected to shrink by 1.5 percent this year, as opposed to 0.3 percent growth predictions a few months earlier.

Banks may also need to be given "further fiscal support" from the public sector, the agency said. Plans are reportedly under way to allow Spanish banks to tap money from the €700-billion-strong bail-out funds to be set up this summer, Sueddeutsche Zeitung wrote on Thursday.

This is the first downgrade for Spain since centre-right Prime Minister Mariano Rajoy took up office in December, pushing for over €50 billion worth of budget cuts in a bid to bring down the deficit from 8.5 percent of GDP in 2011 to three percent next year. Rajoy last week ahead of a fresh series of education and health cuts said "we have no money" to pay for the essential services in full.

S&P warned that Spain may have to take on much more debt than anticipated "unless offsetting eurozone policy measures are implemented to support investor confidence and stabilize capital flows with the rest of the world."

While welcoming Madrid's recent labour market reforms, the agency warned that they would not create employment in the near term. "The already high unemployment rate, especially among the young, will likely worsen until a sustainable recovery sets in," it predicted. Spain has a record unemployment rate of 23 percent, while more than half of people under 25 are out of work.

The US-based agency also took a swipe at eurozone leaders' response to the lingering crisis: "In our view, the strategy to manage the European sovereign debt crisis continues to lack effectiveness."

"We think credit conditions, and hence the economic outlook for Spain, could now deteriorate further than we anticipated earlier this year unless offsetting eurozone policy measures are implemented to support investor confidence and stabilize capital flows with the rest of the world."

Among the envisaged measures, S&P suggested pooling resources and obligations between eurozone countries and harmonising wages across the 17 countries.

Sonny Kapoor, managing director at Re-Define, an economic think tank, also said the austerity-driven policies are not working.

"This is not the last downgrade of Spain's credit rating. Expect more downgrades both for Spain as well as for other Eurozone economies as the flawed austerity-first approach starts to take its toll," he said in an emailed statement.

An informal meeting of EU leaders may take place next month so as to look at more ways to boost growth, EU council chief Herman Van Rompuy said Thursday. It would be the third such meeting this year, without any concrete results having come to bearing yet.