Sept. 4 (Bloomberg) -- The European Union’s rating outlook was cut to negative by Moody’s Investors Service, reflecting the risks to Germany, France, the U.K. and the Netherlands that account for about 45 percent of the group’s budget revenue.
The ratings company lowered the outlook on the EU’s Aaa long-term bond rating from stable, according to a statement released in Frankfurt late yesterday. It also changed to negative from stable its outlook on the provisional Aaa rating for the EU’s medium-term note program.
The change “reflects the negative outlook on the Aaa ratings of the member states with large contributions to the EU budget,” Moody’s said. “The creditworthiness of these member states is highly correlated, as they are all exposed, albeit to varying degrees, to the euro-area debt crisis.”
Ratings of European nations have declined under the sovereign debt crisis and Spain, which held the top Aaa rating from Moody’s between 2001 and 2010, is now on the cusp of junk at Baa3. Those same stresses have hurt the creditworthiness of EU member states that still have top ratings, thanks to their stronger economies or, as in the case of the U.K., being outside the euro region.
Risks of a downgrade to the EU’s sovereign debt rating come from a “deterioration in the creditworthiness of EU member states,” Moody’s said. “Additionally, a weakening of the commitment of the member states to the EU and changes to the EU’s fiscal framework that led to less conservative budget management would be credit negative.”
Chancellor Angela Merkel told a crowd of beer drinkers in Bavaria yesterday that Germany must show solidarity with Europe, and indicated she would back a more active crisis-fighting role at the European Central Bank. Her nation shoulders the largest cost of bailing out weaker governments.
ECB President Mario Draghi told officials yesterday he intends buying government bonds with maturities as much as three years away to bring down borrowing costs for nations in financial distress.
The European Commission, the EU’s executive arm, borrows on behalf of the EU, which has 52.7 billion euros of bonds outstanding, data compiled by Bloomberg show. About 10.7 billion euros of notes come due before the end of 2015, the data show.
The yield premium investors demand to hold the EU’s 4.75 billion euros of 2.75 percent bonds due June 2016 rather than similar-maturity German bonds narrowed 5.2 basis points to 30.4 basis points, according to Bloomberg Bond Trader prices.
“The outlook for the EU’s ratings could return to stable if the outlooks on the ratings of the key Aaa countries with contributions to the EU budget also returned to stable,” Moody’s said of the 27-member group.
European leaders are stepping up shuttle diplomacy this week as they brace for Draghi’s plan to defend the euro from bond-market turmoil. EU President Herman Van Rompuy is traveling to Berlin for talks with Merkel today as Italian Prime Minister Mario Monti welcomes French President Francois Hollande to Rome.
The yield on Italian 10-year bonds declined 5 basis points today to 5.72 percent. That was still 431 basis points more than the yield on similar maturity German bunds. Reports of Draghi’s plan to buy bonds due in as much as three years helped push down yields on Italian two-year notes to the least on record relative to rates on the 10-year notes.
The spread between the two securities increased more than 20 basis points to 337 basis points today, the most since Bloomberg began compiling the data in 1993.
The spread between Spain’s two- and 10-year bonds also climbed, rising to a record 351 basis points, the data show. The country’s 10-year notes yield 6.72 percent.
Draghi faces challenges in winning support among the German public for market intervention. Germany reiterated its support yesterday for Bundesbank President Jens Weidmann, following reports last week that he had considered resigning over his opposition to ECB bond purchases.
“Moody’s believes that it is reasonable to assume the same probability of default by the EU on its debt obligations as the highest rated key members states’ probability of default,” according to the statement. “Whereas Moody’s acknowledges that there are structural features in place that enhance the EU’s creditworthiness, they are in Moody’s view not sufficient to delink the EU’s ratings from the ratings of its strongest key member states.”