Moody's Lowers Greece's Rating Just One Notch

Greece had its credit rating cut one step to A2 by Moody's Investors Service, sparking a rally in its bonds as concern eased that a steeper downgrade would make its debt ineligible as collateral at the European Central Bank.

"There is some relief that it's only one notch," said Peter Chatwell, London-based fixed-income strategist at Calyon, Credit Agricole SA's investment-banking arm. Moody's "talks quite positively about Greece's liquidity situation."

The downgrade puts Greece's rating five steps above non- investment grade and two higher than the levels assigned to it by Standard & Poor's and Fitch Ratings. The ranking is the lowest among the 16 euro-member states and the same as that of Poland and Botswana. Moody's said in a statement today the new rating carries a "negative" outlook, meaning it's more inclined to cut it again than leave it unchanged or raise it.

"Greece is extremely unlikely to face short-term liquidity or refinancing problems unless the ECB decides to take the unusual step of making the sovereign debt of a member state ineligible as collateral for bank repurchase operations," Arnaud Mares, a senior vice president at Moody's in London, said in the statement. It's a "risk that we consider very remote."

Greek stocks rose, with the benchmark ASE Index climbing as much as 3.5 percent.

'Not Too Negative'The yield on the Greek 10-year bond tumbled as much as 23 basis points, the most since Dec. 16, and was 22 basis points lower at 5.73 percent as of 11:00 a.m. in London, from 6 percent yesterday. The yield on the two-year note fell 10 basis points to 3.41 percent.

"It could have been worse," Holger Schmieding, European economist at Bank of America Merrill Lynch in London, wrote in a research note today. "Relative to many other things that have been said about Greece in the last few days, the comments from Moody's are not too negative."

The difference in yield between the 10-year note and that of the German bund, Europe's benchmark government security, narrowed 27 basis points to 250 basis points. It was 184 basis points at the start of this month. Credit-default swaps on Greek government debt dropped 7 basis points to 282, according to CMA DataVision prices.

Budget DeficitPrime Minister George Papandreou's government, which came to power in October promising higher spending and wages, is trying to persuade investors it can cut its deficit from 12.7 percent of gross domestic product to below the European Union's 3 percent limit by 2013. The nation "remains focused" on reducing the deficit and will intensify efforts to bolster the economy, the Finance Ministry said in an e-mailed comment from Athens following the Moody's announcement.

"The government knows what it needs to do, but we'll be looking very closely at implementation," Sarah Carlson, the lead sovereign analyst on Greece at Moody's, said in an interview from London. "Public acceptance of these measures is absolutely key to the success of stabilizing Greece's situation over the long term."

Further cuts from Moody's would cast doubt on the eligibility of Greek debt at the ECB's money market operations. Moody's is the only major ratings company grading Greece above BBB+ after cuts from Standard & Poor's and Fitch Ratings earlier this month. A downgrade of two more notches would mean Greek bonds won't be accepted by the ECB if it reverts to its pre- crisis collateral rules in a year's time.

Further Downgrade?The negative outlook "means that over the next 12 to 18 months, there is a more than 50 percent probability that we downgrade them again," Carlson said.

Goldman Sachs Group Inc. said Dec. 17 that the ECB should revise its collateral rules to end what it says is the Moody's veto over Greek bond eligibility. The ECB currently accepts bonds rated BBB- as collateral after relaxing its rules in response to the financial crisis.

Greek bonds will recover next year, according to Frankfurt- Trust, the investment-management unit of Germany's BHF-Bank.

"We are careful on Greece, we only have small positions," said Ralf Ahrens, head of fixed-income portfolio management at Frankfurt Trust, which has about $20 billion in assets. "But we expect that these bonds will come back again and gain in the first quarter of next year. I can imagine that the spreads will tighten."

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