Italy debt downgrade deepens fears for Euro

S&P’s decision to downgrade Italian debt adds to the pressure on EU legislators to take more decisive action to deal with Europe’s mounting debt problems.

The downgrade strengthens the view on global markets that the Eurozone governments will be unable to resolve their debt crisis.

S&P cut its ratings on Italy to A/A-1 from A+/A-1+ and kept its outlook negative. Italy follows Spain, Ireland, Portugal, Cyprus and Greece as eurozone countries having their credit ratings cut this year. But Italy is also the third biggest economy in the eurozone and considered too big to bail out.

Concern over Italy has mounted in particular over the government’s ability to handle debt equal to 120% of GDP. Italy’s net general government debt is the highest among A-rated sovereigns. It is expected to peak later this year at higher than previously anticipated levels.

The decision surprised the markets, as S&P had not had Italy on review for a downgrade. The timing of the decision also caused surprise, as the announcement came just as measures were being agreed to deal with Greek debt, and as the Italian government was putting into place a €60bn austerity plan. Berlusconi had pledged a balanced budget by 2013.

In its statement, S&P said: “The lowering of the long- and short-term sovereign credit ratings on Italy reflects our view of the Italian economy’s weakening growth prospects and our view that Italy’s fragile governing coalition and policy differences within parliament will likely continue to limit the government’s ability to respond decisively to domestic and external macroeconomic challenges.”

S&P fears the government’s projected €60 billion savings plan will not come to fruition for three primary reasons: “First, we view Italy’s economic growth prospects as weakening; second, nearly two-thirds of the projected budgetary savings in the crucial 2011-2014 period rely on revenue increases in a country already carrying a high tax burden; and, third, market interest rates are anticipated to rise.”

Stefano Rossini, chief executive of, an online mortgage provider, said: “The immediate effects will be to further widen the spread between Italian and German debt.” The spread stands at just under 4%, up from an average over the past 12 months of 1.5%. As Italian government debt lessens in value, so this will directly affect Italian investors, traditionally heavy buyers of the asset class. 

European stock markets slipped on the news, while the euro fell on global markets on fears of a full-blown European banking crisis. An analyst at UBS expected the euro to drop to $1.30 by year-end. Asian stocks suffered but two-year Treasury yields fell to a record low, as Italy’s credit-rating cut boosted demand for the relative safety of US government debt.

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