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updated 11/26/2010 5:07:52 PM ET 2010-11-26T22:07:52

Ireland's banks were hit with downgrades Friday — one to junk bond status — as speculation mounted that an EU-IMF bailout of Ireland could require senior bondholders to help cover the massive losses.

Prime Minister Brian Cowen saw his own hold on power slip another notch, as his ruling Fianna Fail party lost a special election for a long-empty seat in parliament. The winner vowed to force Cowen from office before he can pass an emergency 2011 budget being demanded as part of the international rescue.

Story: Ireland's economy has a split personality

The New York-based Standard & Poor's credit ratings agency said it was lowering Anglo Irish Bank six notches to a junk-bond B grade. It also cut the ratings on Bank of Ireland one notch to BBB+, and downgraded both Allied Irish Banks and Irish Life & Permanent one notch to BBB.

The agency said bonds issued by Anglo are particularly at risk of being discounted as part of an €85 billion ($112.7 billion) rescue mission by the European Union and the International Monetary Fund. The interest rate for Ireland negotiated with the IMF, EU and European Central Bank is likely to be between 6 and 7 percent, much higher than expected, state broadcaster RTE said late Friday.

S&P said Ireland "may be forced to reconsider its current supportive stance toward Anglo's unguaranteed debt." Junior bondholders at Anglo already have been forced to accept losses of 80 percent to 95 percent on their loans.

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"People are already joking on Twitter that Anglo's move is really an upgrade," said Constantin Gurdgiev, finance lecturer at Trinity College Dublin, reflecting widespread surprise that S&P's ratings on Irish banks had been so benign until now. "There really is a serious question as to whether Anglo Irish Bank should even have a banking license."

Gurdgiev said it was inevitable that the emerging EU-IMF bailout would require even senior bondholders to take "a haircut" — lose part of their stake — on the money they could claim back on their loans to Ireland's debt-crippled banks.

"It's becoming clearer by the day there is really no other solution," he said.

A second ratings agency, Fitch in London, said late Friday that each Irish bank soon "could face negative rating action" depending on whether Ireland's deal with EU and IMF negotiators seeks to inflict sacrifices on senior bondholders.

Fitch trimmed its ratings on the lowest-level securities issued by Bank of Ireland and Allied Irish Banks to various grades of junk. Fitch said it "believes that the prospects of enforced burden sharing for (subordinated) debt holders is much more likely, although still not certain."

In the northwest county of Donegal, an Irish nationalist who has vowed to vote against Ireland's austerity plans won a seat in parliament, cutting Cowen's majority to just two seats.

Sinn Fein candidate Pearse Doherty said his dominant performance in a six-candidate field showed that people want to elect a new government that will force foreign banks, not Irish taxpayers, to bear the cost of Ireland's enormous financial crisis.

Doherty had successfully sued the government over its 17-month refusal to permit an election in Donegal, given Cowen's unpopularity and narrow hold on power.

Voters "are telling Brian Cowen to get out of office. It's not clear that this budget will pass. It is completely unfair and unjust to attack the weakest and most vulnerable in this society," Doherty said. "The government should suspend the budget, call a general election, and let the people have their say."

Cowen is unveiling an emergency budget Dec. 7 that seeks to cut €6 billion ($8 billion) from Ireland's 2011 deficit. He and European officials say that budget must be passed to clear the way for the EU-IMF bailout loan for Ireland.

Ireland's 2010 deficit is running at 32 percent of GDP, the highest in Europe since World War II. The country's severe financial problems are rooted in its enormous bailout of Irish banks who gorged themselves on overpriced real estate.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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