The Italian national flag, left, flies alongside the European Union flag (EU) at the Banca d’Italia, the Italian central bank, in Rome, Italy. (Photographer: Alessandra Benedetti/Bloomberg)

Italy Cut to One Step Above Junk by Moody's in Wake of Bond Rout

(Bloomberg) -- Italy’s credit rating was cut by Moody’s Investors Service to one level above junk on concerns about the nation’s fiscal strength and the stalling of plans for structural reform.

The credit score was lowered one level to Baa3 and the outlook was shifted to stable. The move comes amid growing tensions about the country’s budget situation which has helped fuel a sell-off in local debt. Italian bonds plunged this week amid a tussle with European Union officials over its draft budgetary plan and the execution of a debt-exchange operation, with the yield premium for Italian debt over German bonds climbing to levels unseen since 2013.

There has been a “material shift in fiscal strategy, with significantly higher budget deficits planned for the coming three years compared to earlier expectations,” Moody’s said. The assessor noted that the country’s public debt will remain around 130 percent of gross domestic product, “a level that makes Italy vulnerable to future domestic or externally-sourced shocks, in particular to weaker economic growth.”

It also said that while the government’s economic plans are supportive of growth in the near term they don’t amount to a coherent program of reforms “that will lift Italy’s mediocre growth performance on a sustained basis.”

The euro maintained its Friday gains following the announcement, ending the New York trading day up 0.5 percent at $1.1514. Italian bonds were closed at the time of the announcement.

Bond Sell-Off

The sell-off in bonds took the yield on 10-year Italian notes as high as 3.81 percent on Friday, although the rate ended the day at 3.48 percent after comments from the European Union’s Pierre Moscovici noting that officials in Brussels are sensitive to Italy’s political pressures. Officials earlier this week said Italy’s draft budgetary represents “an obvious significant deviation” from EU rules.

The stable rating outlook from Moody’s reflects the broadly balanced risks at the Baa3 rating level, the company said, noting that Italy still exhibits important credit strengths that balance its weakening fiscal prospects.

Italy’s fiscal targets, coupled with recent tensions within the five-month-old governing coalition over a tax amnesty proposal, have fueled skepticism about the viability of the government’s policies and their impact on the economy. The government targets growth of 1.5 percent in 2019, followed by 1.6 percent and 1.4 percent in the following years. By comparison, the median in Bloomberg’s latest survey is for an expansion of no more than 1.1 percent.

EU officials have long signaled it will be difficult for the commission not to reject Italy’s spending plans if the government’s targets remained unchanged, as both the 2019 deficit target at 2.4 percent of output and the so-called structural deficit exceed EU limits. The Commission has demanded smaller gaps for Italy to bring down its debt load, which totals 2.3 trillion euros ($2.7 trillion) in absolute terms and which as a proportion of GDP is the second highest in the euro area, after Greece.

In August, Moody’s extended a review of Italy’s credit rating, saying it needed to get “better visibility” on the government’s fiscal path and reform agenda. It said Friday that it expects higher deficits than the government, at around 2.5 percent of GDP in each of the coming three years.

S&P Global Ratings, which rates Italy two notches above junk, is due to review the country’s ratings Oct. 26. In August Fitch changed the nation’s outlook to negative from stable, while maintaining its foreign long-term credit rating in a decision that was applauded by the Italian government and cited as proof of the credibility of its economic program.

©2018 Bloomberg L.P.