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The rare steep downgrade came in the middle of a European Union summit intended to restore market confidence by creating a permanent financial safety net for the euro zone from 2013 and vowing to do whatever it takes to preserve the single currency.

Moody's cut Ireland's rating to Baa1 with a negative outlook from Aa2 and warned further downgrades could follow if Dublin was unable to stabilize its debt situation, caused by a banking crash after a decade-long property bubble burst.

"While a downgrade had been anticipated, the severity of the downgrade is surprising," Dublin-based Glas Securities said in a note.

News of the latest blow to confidence broke as the 27 leaders began a second day of talks on how to stop contagion spreading from Greece and Ireland to other high-deficit euro zone countries such as Portugal and Spain.

"The recent events have demonstrated that financial distress in one member state can rapidly threaten macrofinancial stability of the EU as a whole through various contagion channels," a draft final summit statement seen by Reuters said.

"This is particularly true for the euro area where the economies, and the financial sectors in particular, are closely intertwined."

At their first session on Thursday, leaders rejected calls for immediate practical steps such as increasing the size of a temporary bailout fund or allowing it to be used more flexibly to buy bonds or open credit lines before troubled countries are shut out of the credit markets.

German Chancellor Angela Merkel, who led opposition to those options, sought to reassure citizens and markets on Friday, declaring: "We are doing everything to make the euro secure."

She said the euro zone would have to move beyond crisis management next year and build step-by-step a common economic policy.

The European Central Bank moved on Thursday to bolster its firepower to fight the debt crisis by announcing it would almost double its subscribed capital.

But analysts said this was chiefly to cover potential losses on euro zone sovereign bonds bought so far, not to step up such purchases to support governments in trouble.

ECB President Jean-Claude Trichet told reporters the central bank's governing council thought it was appropriate to make "additional provisioning" -- a veiled reference to potential losses on euro zone sovereign bonds it has bought.

"IF INDISPENSABLE"

At Germany's insistence, the 27 leaders said the long-term crisis-resolution mechanism, to be added to the EU's governing treaty, would only be activated "if indispensable to safeguard the stability of the euro as a whole."