Italy Bond Rating Cut by Moody’s on Contagion Risks

Italy’s bond rating was cut two levels by Moody’s Investors Service hours before a sale of more than 5 billion euros ($6.1 billion) of debt as the financial crisis threatens to cut off market funding to the euro area’s third-biggest economy.

The ratings company lowered Italy’s government bond rating to Baa2 from A3 and said further downgrading is possible, according to a statement released in Frankfurt today. That’s two levels above junk and one above Spain, according to data compiled by Bloomberg.

“Italy’s near-term economic outlook has deteriorated, as manifest in both weaker growth and higher unemployment, which creates risk of failure to meet fiscal consolidation targets,” Moody’s said. “Failure to meet fiscal targets in turn could weaken market confidence further, raising the risk of a sudden stop in market funding.”

While Italy is on track to bring its budget deficit within the European Union limit this year, its 10-year bond yield has risen above 6 percent in recent weeks after Spain sought a bailout, fueling concern that Italy might be next. Italy had enjoyed a respite from the crisis after Prime Minister Mario Monti’s government took office in November and passed 20 billion euros in austerity measures and overhauled the country’s pension system.
Currency Falls

Italian 10-year bonds slumped in early trading, sending the yield up 12 basis points to 6.03 percent at 9:05 a.m. in Rome. Spanish 10-year yields rose 11 basis points to 6.74 percent, and the euro hovered near a two-year low of $1.2193.

Italy will auction as much as 5.25 billion euros of securities with results due shortly after 11 a.m. local time.

Italy is Europe’s largest bond market and has 1.64 trillion euros of bonds outstanding, according to the website of the nation’s debt agency. That’s the most in Europe.

Moody’s also cited “increasingly fragile market confidence, contagion risk emanating from Greece and Spain and signs of an eroding non-domestic investor base.” The rating “could be downgraded further in the event there is additional material deterioration in the country’s economic prospects or difficulties in implementing reform,” it said.

Investors are paying less attention to the views of ratings companies and relying more on their own analysis. After Moody’s downgraded the biggest Nordic banks in May, bond and share prices rose. Italian and Spanish borrowing costs plunged to the lowest in at least 11 months earlier this year as investors ignored Moody’s downgrades.
Debt Load

Italy, bearer of the euro’s second-biggest debt load relative to gross domestic product, yesterday sold 7.5 billion euros of Treasury bills. Today’s auction includes securities due between 2015 and 2023.

“The current government’s strong commitment to structural reforms and fiscal consolidation has moderated the downward pressure on Italy’s government bond rating,” Moody’s said. “Moody’s recognizes that the government has proposed, and is legislating, a reform program that has the potential to materially improve Italy’s longer-term growth and fiscal prospects.”

Italy will record a structural budget surplus, net of the economic cycle’s effects and one-time measures, of 0.5 percent of GDP in 2013, the International Monetary Fund said in a July 10 report. Still, with debt set to rise to 125.8 percent of GDP this year before peaking at 126.4 next year, Italy is struggling to shake off the risk of contagion.
Longer Contraction

The nation, whose growth has trailed the euro region average for more than a decade, “is expected to continue contracting through the year owing to tight financial conditions, the global slowdown and the needed fiscal consolidation,” the IMF said in the report, confirming its previous forecast of a 1.9 percent contraction this year and 0.3 percent in 2013.

Monti has been lobbying European partners to agree on a plan to give the region’s permanent bailout fund, or ESM, more leeway to buy the bonds of countries meeting their fiscal goals, such as Italy and Spain, in order to lower their borrowing costs.

Moody’s said that “the sovereign’s current Baa2 rating is supported by significant credit strengths relative to other euro-area peripheral economies.”
Unemployment Rate

Italy’s unemployment rate exceeded 10 percent for a third straight month in May and retail sales in April dropped 6.8 percent from a year earlier, the biggest decline since at least January 2001, recent government reports have shown.

Italy’s long-term debt is rated A- by Fitch Ratings and BBB+ by Standard & Poor’s, according to data compiled by Bloomberg.

“Should Fitch cut Italy’s rating, it may trigger massive selling of the nation’s bonds by investors, including conservative Japanese pension funds and overseas money managers that have to sell based on credit ratings,” said Shinji Kunibe, chief portfolio manager for fixed-income investment in Tokyo at Nissay Asset Management Corp.