30th January 2012
Late on Friday evening we saw the continuation of a theme which is becoming more and more familiar. This involves Euro zone government bond markets improving with prices rising and yields falling. Examples of this on Friday involved the Italian ten-year bond yield dropping below 6% and the Spanish equivalent dropping below 5%. However this is then followed by a ratings agency downgrading the credit rating of some Euro zone nations. Previously it has been American agencies who have played this “game” but this week it was the (mostly) French owned Fitch which took centre stage by downgrading 5 countries.
Fitch on Spain and Italy
A re-assessment by Fitch of the potential financing and monetary shocks that members of the eurozone face in light of the increasing divergence in economic, monetary and credit conditions and prospects across the region, which is also a factor in the downgrades of some other eurozone sovereign governmens.
– Spain’s significant fiscal slippage in 2011 and deterioration in the macroeconomic outlook with adverse implications for the medium-term outlook for public finances.
To which it added this:
The new government has also announced it will require the Spanish banks to increase their provisions by EUR50bn (EUR35bn net of tax)……………the Spanish banking sector as a whole will likely need more capital support from the state
Fitch has the same first reason here i.e a general Euro zone deterioration and then a second one which is somewhat self-fulfilling.
a permanent upward shift in Italy’s relative cost of fiscal funding and consequently an increase in the interest rate growth differential with adverse implications for long-run public debt dynamics
So there you have it Italy is in trouble because it is in trouble! This is confusing what is mostly a symptom with a cause to my mind. And of course as noted above, if high bond yields were the problem they were showing signs of improving. It would be much better I think if Fitch had made more of a case for a cause for example Italy’s high public debt and low potential growth rate have rendered it especially vulnerable
And that this is an issue going forwards.
the greater reliance on raising revenues (which account for around two-thirds of the planned deficit-reduction) implies that the tax burden and public spending will remain high by international standards
Added to this is the genuine doubts that Italy can carry out these reforms. For example will her unelected technocratic government be able to stay the course should the going get tough?
New data this morning has confirmed the problems ahead for both Italy and Spain. Starting with Spain we have seen her economic growth rate be confirmed at -0.3% for the last quarter of 2011 and if we look back to her recent history we see that it was Q2 of 2008 where growth was zero and that she is looking in overall terms at a four to five-year slow down. Italian business confidence has dipped to a reading of 92.1 which is the worst for two years.
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