Investors braced for another rocky day after Italy is downgraded

Posted on September 20th, 2011 | Categories - News

European stock markets are likely to open lower this morning and can expect a day of volatile trading after news that Italian debt was downgraded late last night by ratings agency Standard & Poor’s.

It is not just European markets that are likely to be affected. Markets in the US are likely to open lower too and Asia has already closed lower, as fears grow about the level of European debt and the ability of governments to steer a safe course through the crisis.

In the UK the FTSE 100 fell yesterday by just over 2%, principally because of continuing worries about the levels of debt in Greece, the news over night about Italy will do nothing to reverse yesterday’s losses.

Downgrade

Italy has Europe’s second largest debt burden and late last night Standard & Poor’s downgraded the country’s rating from A+ to A, adding that the outlook was “negative”.

Over recent weeks the cost of borrowing for the Italian government has soared and this announcement will further increase these costs, making it even harder for the already unpopular austerity plan to be implemented.

In a statement Standard & Poor’s said:  “In our view, Italy’s economic growth prospects are weakening and we expect that Italy’s fragile governing coalition and policy differences within parliament will continue to limit the government’s ability to respond decisively to domestic and external macroeconomic challenges,” S&P said in a statement. “The measures included in and the implementation timeline of Italy’s National Reform Plan will likely do little to boost Italy’s economic performance, particularly against the backdrop of tightening financial conditions and the government’s fiscal austerity program.”

Italy now joins an inauspicious club including Greece, Ireland, Spain, Portugal and Cyprus, who have all had their ratings downgraded this year.
Reaction to the downgrade was strong, Carl Weinberg of High Frequency Economics said: “Coming at a time when the world’s financial markets are on edge, warily watching for a default by Greece with knock-on unknown effects on the financial system, the optics of this downgrade stink.”

He continued:”Perceptions are more important than realities.”

“Investors will be shaken, as if they are not shaken enough already, by what appears to be decaying conditions for another sovereign issuer.”

Stock market volatility

World markets were already down yesterday on the back of renewed fears over Greece and differences between the bail out “troika” of the International Monetary Fund, European Union (EU) and the European Central Bank (ECB), which they tried to patch up yesterday.

The move by Standard & Poor’s will only fuel the fear that the debt contagion will sweep Europe.

The European markets are likely to open lower this morning and will continue to look to both government and the world’s institutions for strong leadership.
Marc Lansonneur, of Societe General Private Banking agrees: “The sentiment of contagion is definitely stronger than before,” he said.

“If there is no trust in the system then anything is possible. The less trust you have the more expensive the money is to borrow for European countries and the worse the crisis is. It then starts fuelling itself.”

Robert ZoellickRobert Zoellick (left) chief of the World Bank warned: “The drop in markets and confidence could prompt slippage in developing countries’ investment and a pull-back by their consumers, too.”

The downgrade is also likely to reignite the debate over the ratings agencies. The European Commission has already threatened increased regulation and talk of setting up an “independent” European ratings agency is likely to increase. Although banks and other financial institutions have been dismissive of the idea.