RECENT EVENTS
On Friday, 13 January 2012, after the close of the markets, rating agency Standard & Poor’s downgraded the rating of nine European countries, including Italy, by one or two notches. Italy’s rating was lowered from “A” to “BBB+”.
REASONS FOR THE DOWNGRADE: MOSTLY EXTERNAL, BUT DOMESTIC AS WELL
Concerns over domestic growth
The Rating agency, while showing appreciation for the efforts made to date by the new Italian government to resolve the country’s fiscal imbalances, expressed scepticism on the implementation of the second phase of the structural consolidation process. Its concern stems from doubts that, after an initial phase in which focus was very much on the fiscal austerity pillar, the government may be stripped of the political support necessary to realise the ambitious reforms preannounced by Mario Monti.
Policy initiatives taken so far by European policymakers deemed insufficient
This is the main reason behind the wave of credit rating downgrades that hit as many as nine countries. The agency is convinced European policymakers are not doing enough to resolve the crisis in terms of appropriation of resources and operating flexibility.
EFFECTS ON THE MARKETS
The two factors which triggered the downgrade had been widely digested by the market, and were therefore already discounted by spread and yield levels. This explains the very bland reaction of the markets, which, in fact, moved in the direction opposite the one indicated by S&P after the announcement of the decision. Yield spreads narrowed in all the countries affected by the downgrade, except Portugal, which shed the progress made over previous sessions.
WHAT SHOULD WE EXPECT NOW?
First of all, further actions by the rating agencies could take place: after the country downgrades, S&P is now downgrading the ratings of other issuers, such as the EFSF (European Financial Stability Fund) and banks; presumably, in typical herd logic, other rating agencies will follow S&P’s example.
However, this downgrade process may be read as a signal prompting European policymakers to do more.