S&P Cuts Italy’s Credit Rating

Italy's credit rating was cut by Standard & Poor's, the country's first downgrade in five years, as Greece's worsening fiscal crisis fans concern that contagion will engulf countries such as Spain and Italy.

S&P lowered its rating last night to A from A+, saying weak economic growth, a “fragile” government and rising borrowing costs would make it difficult to reduce Europe's second-biggest debt. The yield on Italy's 10-year bond rose 8 basis points to 5.662 percent, 385 basis points more than similar German debt. The cost of insuring Italy against default rose to a record.

The European Central Bank was forced to buy Italian and Spanish bonds last month after their yields surged to euro-era records on concern they'll be the next victims of the two-year-old debt crisis that led to bailouts for Greece, Ireland and Portugal. Moody's Investors Service is set to decide in the next month whether to downgrade Italy and Spain, while Greece struggles to convince international creditors it deserves its next bailout payment to stave off a default.

“Investors have become more bearish about Italy mainly because euro-zone leaders failed to create a firewall around the bloc's solvent governments,” said Nicholas Spiro, head of Spiro Sovereign Strategy, a London-based consulting firm. “They let a crisis in the narrow periphery of the euro zone morph into one affecting the solvent core” and “we're now dealing with the consequences.”

Greek Talks
European Union and International Monetary Fund officials held a second conference call in as many days tonight with Greek Finance Minister Evangelos Venizelos, who is try to convince them that Greece deserves the sixth payment of its original 110 billion-euro bailout.

Italy follows Spain, Ireland, Portugal, Cyprus and Greece as euro-region countries having their credit rating cut this year. Prime Minister Silvio Berlusconi passed a 54 billion-euro ($74 billion) austerity package this month that convinced the ECB to buy its bonds. The plan to balance the budget in 2013 wasn't enough to sway S&P, whose rating on Italy remains five steps above non-investment grade and three below that given by Moody's.

Speculation, Reality
“The valuations of Standard & Poor's seem dictated more by newspaper speculation than by reality, and appear influenced by political considerations,” Berlusconi's office said in an e-mailed statement, adding that the government will meet its budget targets as it prepares measures to boost economic growth.

Responding to the government's statement, S&P said its rating was based on an independent analysis of Italy's fiscal and economic outlook and debt prospects. “S&P's sovereign ratings are apolitical” and indicate “how different political initiatives may impact financial accountability,” the rating company said in an e-mailed statement.

The jump in Italy's yields threatens to raise borrowing costs as the country prepares to sell more debt. Italy still needs to sell more than 50 billion euros of bonds this year, with the three auctions set for next week starting on Sept. 27.

Spain sold 4.46 billion euros of 12-month and 18-month bills, just below its maximum target, and its borrowing costs rose even as the ECB moved to support the nation's debt.

ECB Purchases
The ECB purchased more Spanish and Italian bonds today, according to five people with knowledge of the transactions. The yield on Spain's benchmark 10-year bond, which reached a euro-era high of 6.3 percent on July 18, was little changed after the auction at 5.36 percent.

The worsening debt crisis is also eroding confidence among the region's banks, crimping liquidity and pushing the spread between secured and unsecured interest rates to the widest since December 2008. The ECB said on Sept. 15 it will lend dollars to euro-area banks with the Federal Reserve and other central banks to ensure access to the U.S. currency.

“There's real doubt whether all countries can manage their debts and how the European banking system can withstand the crisis,” Finland's Prime Minister Jyrki Katainen said in a television interview on Finland's MTV3 today.

S&P warned that it may cut its rating on Italy's bank when it first put the country's creditworthiness on review in May. UniCredit SpA, Italy's largest bank, has lost more than half its value this year on concern over its holdings of Italian debt. Intesa Sanpaolo SpA, the No. 2 bank, is down 44 percent in 2011.

U.S. Rating
The Italian decision also comes just weeks after S&P stripped the U.S. of its AAA rating for the first time. While the Aug. 5 move roiled global markets, bond investors ignored S&P's warnings about U.S. creditworthiness and piled into Treasuries. The yield on the benchmark U.S. government bond fell to a record 1.8770 on Sept. 12.

S&P said it lowered its outlook for Italy's growth to a 0.7 percent annual average for 2011 to 2014, from a prior projection of 1.3 percent. The slowing economy will make it harder for Italy to achieve its fiscal targets, the rating company said.

“The high level of public debt leaves Italy on an unstable equilibrium,” Barclays Capital Research economists including Julian Callow said in an e-mailed note today. The government has not come up with any “structural reforms” to improve long-term economic growth prospects and is unlikely for now “to deliver on this front.”

Bloomberg News

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