It cut its rating on long-term bonds to Ba1 from Baa3 and on short-term debt to “Not Prime” from “Prime-3” with a negative outlook.
The term negative outlook means that the agency does not rule out lowering the notations again in the medium term.
Cyprus had been at risk of this downgrade by Moody’s since the agency put it under negative watch at the beginning of November.
The decision makes Moody’s the second rating agency to classify debt issued by Cypris in the high-risk category.
Standard & Poor’s took a similar decision in the middle of January, lowering its notation by two notches to BB plus which is equivalent to a rating of Baa3 by Moody’s.
The third main agency Fitch Ratings downgraded Cyprus by one notch at the end of January to BBB minus.
The agency said it had changed the ratings because of the “increased risk that the Cypriot government would have to provide renewed financial support to the country’s banks because of their exposure to the Greek government and economy, and the commensurate impact of such measures on the government’s own financial strength.”
It had also taken into account “the likely impact on market confidence in Cyprus stemming from these banking-sector concerns, as well as broader uncertainties about Europe’s macroeconomic prospects and institutional frameworks.
“Overall, the fragile market confidence in Cyprus, which has already led to a loss of access to international debt markets, is likely to continue, with a high potential for further shocks to funding conditions for the sovereign and the domestic banks.”
However, Moody’s said it had limited its action to one notch “in acknowledgement of the positive developments in Cyprus since Moody’s placed the country’s rating on review for downgrade in November 2011.”
It said: “In particular, Moody’s notes that the Cypriot government has now passed a large-scale fiscal consolidation programme, which contains a greater number of structural changes to public-sector expenditure than had been anticipated.
“These measures are likely to enable the country to achieve a deficit reduction of around three percentage points of GDP in 2012.”