The view from the rating firms contrasts with the sanguine attitude of investors who, flush with central bank cash and reassured by the European Central Bank's promise to take whatever measures are necessary to safeguard the common currency, have been buying lower-rated bonds because of the higher returns or 'yields' they earn on them.

On the face of it, conditions for sovereign borrowers in the euro zone are improving. Ireland and Portugal - whose bonds are already rated as 'junk', or below investment grade - are gradually emerging from international bailout programmes and returning to bond markets for their borrowing needs, while yields on benchmark bonds issued by Spain and Italy, two other countries that have felt the heat of the crisis, have fallen to around 2-1/2 year lows after hitting unsustainable peaks above 7 percent at crisis points last year or the year before.

Analysts say the recent market moves have been because plentiful liquidity provided by the ECB and other major central banks has outweighed unfavourable fundamental factors such as the fact that most euro zone economies continue to contract, while annual budget deficits and public debt levels remain stubbornly high.

Ratings agencies warn that may change.

"The current favourable market environment is not something that Moody's is sure will be sustained," Alastair Wilson, chief EMEA credit policy for the agency, told Reuters. "The longer the underlying problems - growth, debt, institutions - remain unaddressed, the greater the potential for further shocks."

Rating firms have a track record of making decisions that at times contrast with the market sentiment. In the past year, Moody's reaffirmed a negative outlook for the ratings of Ireland, Portugal and Italy, Fitch downgraded Italy, while Standard & Poor's stripped France of its AAA rating.

The most recent example was last month's downgrade of Slovenia by Moody's, just before the country avoided a bailout by selling $3.5 billion of bonds in a sale that attracted plentiful buyers.

The downgrade did not cause forced selling of Slovenian bonds as they are not part of major bond indexes, but a similar move on larger countries is likely to be more damaging.

Rated only one notch above junk by Moody's and Standard & Poor's, Spain is most at risk of forced selling, since some institutional investors only hold investment grade bonds or constituents of investment-grade bond indexes.

"They were not at all shy of junking Slovenia, and this could change market perception of how high the bar is to junk Spain," said David Schnautz, rate strategist at Commerzbank in New York.

Data on how many funds are tracking the bond indexes Spain is part of is not readily available. An exclusion from all indexes could cause 30-40 billion euros of selling - 5-6 percent of outstanding central government debt, JPMorgan estimates.

Analysts say domestic banks and foreign hedge funds - using the cheap cash available - are likely to step in and buy the bonds that institutional investors sell, but they would demand more of a premium to hold Spanish bonds over safe-haven German bonds.

"A year ago it would have moved the (German/Spanish 10-year yield) spread by 200-300 basis points or more," said JPMorgan strategist Nikolaos Panigirtzoglou.

"Now, because of the ...(ECB) backstop and limited (euro zone) break-up risks, a downgrade to junk would probably move it by less than 100 bps, everything else being equal."

Still, 100 bps is how much the 10-year Spanish/German yield spread has tightened in 2013 alone. It last traded at about 285 bps. ING estimates such a move in a short period of time could have knock-on effects on Italy.

COMPLACENCY RISK

Easy money conditions are intended to buy time for national and euro zone policymakers to fix the structural deficiencies that led to the debt crisis, the ECB says. But the risk is that they do the exact opposite, Moritz Kraemer, head of European sovereign ratings for Standard & Poor's, told Reuters.

"If conditions are perceived to be easy, the incentive to engage in reforms may be reduced, which is the complacency risk," Kraemer said. He added that S&P regards central bank-influenced liquidity conditions as potentially "cyclical, volatile and outside the immediate control of the sovereign".

The ECB has not printed money like the Federal Reserve, the Bank of England and the Bank of Japan have, but it has provided banks with unlimited long-term loans (LTROs) and created a just-in-case bond buying programme (OMT), as yet untested.

"The ECB's willingness to support the market with LTROs and the OMT is ... positive. However, it is not going to be able to solve the crisis," Wilson of Moody's said.

Fitch Ratings did not respond to Reuters requests for comment. The agency rates many euro zone countries higher than its competitors.

(Additional reporting by Emelia Sithole-Matarise, graphics by Ana Nicolaci da Costa and Stephen Culp; Editing by Will Waterman)

By Marius Zaharia