ECB Moves to Support Italy

Standard and Poor’s recent downgrade of Italy’s “sovereign-rating” came as a surprise to both analysts and government bond-investors. In an effort to temper a sudden rise in bond-yields and to avert fears of debt-contagion, the European Central Bank (ECB) quickly moved to buy up Italian government bonds. Even though the prospects for Italy’s economic performance are not positive, the timing and the effects of the downgrade justify concerns over the power of the big rating agencies.

By Tom Mudd and Christopher Emsden

Wall Street Journal
September 20, 2011


The European Central Bank stepped into the market to buy Italian government bonds Tuesday after a sovereign-rating downgrade by Standard & Poor's Corp. raised new concerns about Italy's solvency amid a slowing economy.

The ECB move was aimed at keeping down yields on Italian debt as nervous investors demanded higher risk premiums. The yield on the 10-year Italian government bond rose 0.3 percentage points to trade at 5.603% in early trading Tuesday, off an earlier high of 5.67%.

The ECB for weeks has been acting to support the markets for Italian and Spanish government bonds, where recent slippage on debt-contagion fears has threatened to send their borrowing costs spiraling up to unsustainable levels.

"They have bought Italy in small clips and we have seen the eight-year bond being picked up," a senior trader in London said.

Late Monday, S&P lowered Italy's credit rating to single-A from single-A-plus and kept a negative outlook on its debt, which means Italy is at risk of further downgrades. Analysts at Barclays Capital said the negative outlook was a surprise and the downgrade came earlier than expected.

The downgrade is worse than a similar move still expected from Moody's Investors Service because S&P's credit rating for Italy was already the lowest of the three major credit-rating companies.

"It's usually less relevant when the downgrade comes from an agency that has a high rating [on a country], but Standard & Poor's had the lowest," said a Milan fund manager.

The downgrade helped send the cost of insuring Italian government debt against default to a new record Tuesday, leading a broad-based rise in risk perceptions in Europe.

S&P also lowered its growth forecast for Italy to 0.7% from 1.3% in 2011-14. The rating company believes slower growth will make it hard to achieve fiscal targets.

The Italian government played down the S&P downgrade, saying in an e-mailed statement Tuesday that the rating firm seemed to be responding more to press reports than actual facts.

Prime Minister Silvio Berlusconi's government is set to revise its 2011 forecasts for growth in gross domestic product to 0.7% from 1.1%, Italian daily Corriere della Sera reported Tuesday without citing sources. Rome is also going to cut 2012 forecasts to around 1% from the previously announced 1.3%, the newspaper added.

S&P said it now expects Italian real GDP to expand by 0.7% on average each year through 2014. The agency acknowledged that was a drastic cut from the 1.3% its analysts forecast in May.

Data on industrial production Tuesday added to the picture of an economy that is struggling to make any headway. Industrial orders—a proxy for future output and employment levels, income tax trends and more—rose only 6.5% from a year earlier in July, ending more than a year of mostly double-digit levels, according to data released by Istat.

Industrial data suggest Italian GDP may even contract in the third quarter, said Deutsche Bank economist Marco Stringa.

S&P cited concerns about slowing growth in its downgrade of the euro zone's third-largest economy. The rating firm will hold a conference call on its downgrade decision at 1430 GMT.

The Italian downgrade also suggests further trouble could be in store for the broader euro zone, said Barclays Capital global macro strategists. The move shows that "contagion risks remain elevated" and that the "market's skepticism extends beyond Italy and now questions the survival of the euro area itself," they said.