Spain, Italy, grexit and politics: the top five risks for the eurozone

Even if the stress level in the eurozone has reached its peak and should decline over the next weeks, investors should keep their attention on five risks, according to Ken Orchard, sovereign credit analyst at T. Rowe Price.

Spain and Italy could decline to sign memos of understanding and enter programs – Spain has already refused to request assistance from the European Financial Stability Facility/European Stability Mechanism and Spanish Prime Minister Rajoy refused to say whether Spain would make an official request for assistance or not, Orchard warned. Meanwhile, Italian prime minister Mario Monti has been ambivalent about requesting assistance.

Sovereign ratings downgrades – Moody’s has stated that countries in official rescue programs cannot be rated investment grade and Spain and Italy are likely be downgraded to below investment grade after they request financial assistance.
“The short-term market reaction would probably be negative. Longer-term, however, we think the market will ignore a Moody’s downgrade,” the analyst said. S&P and Fitch are likely to view the combined actions by the European Central Bank as supportive for Spain and Italy and to maintain their ratings in the BBB range.

Greek political problems or a euro exit are likely – “Greece is a powder keg. The economy is still in deep recession, and unemployment is rising,” Orchard warned.
A government collapse or a departure from the eurozone are still likely next year. We believe this is one of the reasons that the ECB wants bigger firewalls for Spain and Italy.

The German constitutional court could reject the ESM – On September 12, the German high court will rule on September 12 whether the ESM is consistent with the German Basic Law.
“The high court has never ruled against a crisis support mechanism, and we do not expect it to do so this time, but it could place some constraints around the ESM’s operations and size,” said the analyst.

Italian politics could be destabilizing – Italy is expected to hold parliamentary elections in April 2013. Some parties could run on an anti-austerity/anti-bail-out ticket. “Some, notably the “5 Star Movement”, may even run on an anti-euro ticket. That could be destabilizing,” he said.

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