Italy passes market test


Italy passed a tough market test today as its three-year borrowing costs fell well below 5 per cent at an auction hours after Moody's cut the country's rating to two notches above junk status.

The US rating agency surprised markets today by lowering Italy's sovereign debt rating to Baa2 amid persistent worries about Spain's ability to sort out its banking problems, concerns about a Greek exit from the euro and doubts over Italy's long-term resolve to push through much-needed reforms.

The Italian bond market recovered some ground as Italy managed to sell €5.25 billion in medium and long-term bonds, its top targeted amount, fetching the lowest yield since May on a new three-year issue.

Yet, the yield difference between 10-year Italian government bonds and their German equivalent remained at around 480 basis points, a high level that is frustrating the government in Rome and that Federico Ghizzoni, who heads of Italy's biggest bank by assets UniCredit, has called 'unsustainable'.

Mr Monti this week did not rule out tapping euro zone bailout funds through a new bond-buying system to help ease Italy's borrowing costs, a move that Moody's says could trigger a further downgrade.

Three-year bond yields had risen to a six-month peak of 5.3 per cent in June, ahead of a cliffhanger Greek election that some feared may have forced the country out the euro zone and after an unconvincing initial attempt to bail out Spanish banks.

In its comments, Moody's said the probability of Greece leaving the single currency had increased in recent months as well as the likelihood Spain may require external aid.

"In this environment, Italy's high debt and significant annual funding needs of €415 billion, 25 per cent of GDP, in 2012-13, as well as its diminished overseas investor base, generate increased liquidity risk," Moody's said.

The country's economy is projected to contract by as much as 2 per cent, dimming the prospect of implementing reforms.

Moody's took its ratings for Italy below those from agencies Standard & Poor's and Fitch, potentially triggering further investment outflows from Italy.

Analysts estimate that foreigners hold about one third of Italy's public debt, down from 40 per cent a year ago. Data from Italy's banking association ABI also showed that foreign deposits at Italian banks were down 20 per cent year on year.

"This is just Moody's opinion. I think our country, and our manufacturing system, is much stronger than the Moody's evaluation suggests," Italian business association head Giorgio Squinzi said.