Italy’s Rating Cut One Level by S&P as Greek Crisis Fans Contagion Concern

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+, with a negative outlook, 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 9 basis points to 5.674 percent, 387 basis points more than similar German debt. The cost of insuring Italy against default surged 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, as 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 trying 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.

The International Monetary Fund cut its growth forecast for Italy next year to less than a quarter what the government predicts in its plan to balance the budget. The economy will expand 0.3 percent in 2012, compared with the 1.3 percent forecast in June, which matches the government’s prediction.

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 prospects for reducing a debt burden of about 120 percent of gross domestic product. “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.

Another Cut?

The negative outlook on Italy means there’s a one-in-three chance that S&P will lower the nation’s rating again within the next 12 to 18 months, Moritz Kraemer, S&P’s managing director of European sovereign ratings, said in a conference call today.

Italy must “reinforce” its vow to balance the budget and convince the world it’s “serious,” Sergio Marchionne, chief executive officer of Fiat SpA, Italy’s biggest manufacturer, said in an interview in London today. “The time for nebulous, unspecified and non-detailed commitments is gone,” he said, adding that the austerity question is “crucial.”

Debt of 1.9 trillion euros -- more than Spain, Greece, Ireland and Portugal combined -- leaves Italy vulnerable to any advance in yields as it refinances maturing 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.

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.

Sagging Confidence

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.

S&P warned that it may cut its rating on Italy’s banks when it first put the country’s creditworthiness on review in May. UniCredit SpA (UCG), 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.

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 growth prospects and is unlikely for now “to deliver on this front.”

To contact the reporter on this story: Jeffrey Donovan in Rome at jdonovan26@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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