The ratings agency Moody’s has cut its rating of Italian credit worthiness by three notches from Aa2 to A2. This implies that Moody’s is suggesting that investment in Italian government bonds has become riskier, suggesting that the chances of a default have increased – after all, the whole point of providing a credit rating is to tell investors how likely they are to get burned. Perversely, the agency publicly stated that the chances of an Italian default were low.
The reasons given by the ratings agency for cutting the Italian credit rating will have sent a shudder through other nations within the EU that have substantial debts. According to Moody’s a “material increase in long-term funding risks for the Euro area” was to blame for the downgrade – obviously this reasoning could be applied to any other Eurozone member. The cost to Italy of borrowing through issuing government bonds is set to rise as a result of the downgrade.
Whilst Italy has modest borrowing needs at the moment and private debt levels are reasonable, the public sector debt is set to hit 140% of GDP this year. Paying down public sector debt has become a political imperative across the EU – besides, the convergence criteria for joining the Euro was that public debt should not exceed 60% of a nation’s GDP. This figure has been surpassed by a number of countries within the block as their governments strove to fend off the worst of the global financial crisis and prevent their own financial sectors from imploding.
Despite Moody’s actions, stock markets across Europe rallied on rumours that EU leaders are considering concerted action to bolster banks within the block. The news was enough to restore 3 to 5% to the value to European bourses. The Euro edged up against Sterling and the US Dollar in volatile (read uncertain) trading. Traders are no doubt waiting for firm news to emerge from the EU’s political elite on actions to settle the sovereign debt crisis.