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S&P : update on S&P’s downgrade of Italy

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Italy has seen its credit rating cut by ratings agency Standard & Poor’s from ‘A+’ to ‘A’, with a negative outlook.

The move is the rating agency’s first downgrade of the Eurozone’s third-largest economy since 2006. As for the reasons behind yesterday’s decision, S&P noted Italy’s “weakening economic prospects” and the difficulty of the “fragile governing coalition” being able to respond decisively to the debt crisis.

Moody’s also stated it would continue to review Italy’s finances, although ultimately we expect them to follow S&P’s lead and assign a lower credit rating to the country.

Though we remain very cautious across the fixed income markets of Europe’s southern periphery, especially Greece, Portugal and Ireland, we view the fundamental story for Italy as a little more constructive.

Compared to these peripheral countries, Italy’s fiscal position is more favourable, with relatively low levels of private indebtedness, and if the government successfully follows through on its plans for fiscal reform including, in full, the €60bn austerity programme which has recently been agreed by parliament, then this could go some way to achieving a balanced budget by 2013.

However, the task ahead for the Italian Government ought not to be underestimated. Current plans require measures of institutional reform, revenue expansion and cost cutting to an extent never before executed within this economy – there are sure to be both successes and failures along the way and the prospect remains for a period of heightened volatility across all Italian risk assets.

We do take some comfort from the European Central Bank continuing its buying programme of Italian (and Spanish) bonds though believe this is only a temporary measure ahead of the full ratification of the enlarged powers of the European Financial Stability Facility possibly in mid-October.

Source : S&P