FT Alphaville " Moody's cuts Italy two notches Moody's left Italian sovereign debt two notches above junk on Friday, after downgrading it from A3 to Baa2. The rating agency cited "signs of an eroding non-domestic investor base" for Italy's bonds. Well, with credit rating downgrades themselves increasingly placing Italy's position in benchmark international bond indices in danger - it's a bit of a sticky situation. From the Moody's release (Italy also remains on negative outlook): The first key driver underlying Moody's two-notch downgrade of Italy's government bond rating is Italy's increased susceptibility to event risk. As discussed in a recent Special Comment, "European Sovereigns: Post-Summit Measures Reduce Near-Term Likelihood of Shocks, But Integration Comes at a Cost," Moody's believes that the normalisation of sovereign debt markets could take a number of years, with political event risk and the risk of sovereign defaults increasing as the crisis persists. Moreover, events in Greece have deteriorated materially since the beginning of 2012, and the probability of a Greek exit from the euro area has materially increased in recent months. Likewise, an increased likelihood that Spain might require further external support against the backdrop of economic weakness and increased vulnerability to a sudden stop in funding. In this environment, Italy's high debt levels and significant annual funding needs of €415 billion (25% of GDP) in 2012-13, as well as its diminished overseas investor base, generate increasing liquidity risk. The 29 June euro area summit advanced the idea of allowing European Financial Stability (EFSF) and European Stability Mechanism (ESM) funds to be used to stabilise sovereign funding markets, which implicitly recognises that these tools may be necessary to sustain Italy's access to affordable credit. However, given the size of the Italian economy and the size of the government's debt load, there is a limit to the extent to which these support mechanisms can be used to backstop such a large, systemically important sovereign. However, Italy benefits from its systemic importance for the euro area, giving it leverage in the political process as reflected in the results of the 29 June euro area summit. Moody's also pointed to a worsening domestic economy and delay in Italy's fiscal reforms. "The political climate, particularly as the Spring 2013 elections draw near, is also a source of implementation risk," the agency added. And as if by cue... Related link: Downgrading a eurozone sovereign: you know the drill - FT Alphaville This entry was posted by Joseph Cotterill on Friday, July 13th, 2012 at 1:17 and is filed under Capital markets. Tagged with credit ratings, eurozone, Italy, moody's, sovereign credit ratings, Sovereign debt.