UPDATE 2-Moody's cuts ArcelorMittal debt to junk status

* Cuts debt to Ba1 from Baa3

* Says outlook remains negative, steel markets challenging

* Says ArcelorMittal debt reduction efforts ``modest''

(Adds ArcelorMittal comment, bonds, CDS impact)

BRUSSELS, Nov 6 (Reuters) - Agency Moody's cut its rating for the debt of ArcelorMittal to junk with a negative outlook on Tuesday, reflecting a collapse in world steel markets it said would get worse before they got better.

The move brings the world's largest steelmaker to the verge of a complete loss of its investment grade status, something the company had said it was not ``imperative'' to avoid and would cost a relatively contained $100 million.

But it underlines the difficulty ArcelorMittal has faced in cutting back on debt and raising cash through sales of assets at a time when demand for metals has fallen on the back of the first proper easing of Chinese economic growth in years.

The spread on ArcelorMittal bonds widened and the cost of insuring its debt against default rose after the downgrade.

Its shares also briefly dropped to a session low of 11.675 euros, down 1.6 percent on the day, but then bounced back to close 3.2 percent higher.

``It was the consensus view to buy (the shares) once the downgrade happened,'' said a London-based analyst who declined to be named.

Credit Suisse said ArcelorMittal's desire to retain its investment grade status with Moody's meant a rights issue was a possibility. With the loss of that status, the risk of a dilutive rights issue had been ``put to bed''.

Moody's cut the company's senior unsecured notes to Ba1 from Baa3, joining Standard & Poor's in rating ArcelorMittal one notch below investment grade.

S&P took its action in August, shortly after ArcelorMittal's second-quarter results. At that time, Moody's cut its outlook to negative, saying the company needed to lower net debt by $5 billion by early 2013 to avoid a downgrade.

Moody's said on Tuesday ArcelorMittal's third-quarter results, published last week, were the worst since the second quarter of 2009, reflecting the deterioration of global steel markets. The steel company scrapped its outlook and cut its dividend.

Moody's said it was likely to keep a negative outlook until the global economy and steel markets improved, ArcelorMittal carried out more assets disposals and other actions to boost credit and comfortably complied with financial covenants.

The company said in a statement its financial position was robust, its plans to improve its debt-to-earnings ratios were on track and it expected further progress in the coming months.

Its net debt rose by $1.2 billion during the third quarter to $23.2 billion at the end of September. It now sees full year core profit (EBITDA) of about $7 billion.

Moody's said challenging conditions would continue for several quarters and the amount of debt reduction needed to hold its previous Baa3 rating was either unattainable or, if attempted through asset sales, would materially impact earnings.

``The announced actions taken by the company thus far to preserve cash and reduce leverage.

It said ArcelorMittal might breach credit facility covenants in June 2013 unless it repaid a considerable amount of debt or secured amendments with lenders.

(Additional rporting by Natalie Harrison; Editing by Dan Lalor)