Italy government bonds downgraded by Moody’s

Moody’s Investors Service Monday downgraded Italy’s government bond ratings to “A2” with a negative outlook from “Aa2,” the result of high debt, a weak global economy and political uncertainties that delay corrective action.

While the change moves the rating down three notches, it is still investment grade. Moody’s affirmed the short-term ratings at Prime-1.

Moody’s said the size of the rating action is largely driven by the sustained increase in the country’s susceptibility to financial shocks, however, the “A2” rating indicates the risk of default by Italy remains remote.

“Nonetheless, Moody’s believes that the structural shift in sentiment in the euro area funding market implies increased vulnerability of this country to loss of market access at affordable rates that is incompatible with a ‘Aa’ rating,” the analysts said.

The action follows the Sept. 19 one-notch downgrade by Standard & Poor’s Ratings Services, which cut Italy’s long- and short-term sovereign credit ratings to “A/A-1” from “A+/A-1+.” That rating is still five steps above junk status. S&P analysts cited weakening economic growth for the nation and higher-than-expected levels of government debt.

The European Central Bank had demanded stiff austerity measures but doubts persist about how serious Italy is about coming to grips with its debt.

The Italian economy continues to face significant challenges due to structural economic weaknesses including low productivity and important labor and product market rigidities, Moody’s said. These problems have slowed growth rates over the past decade and continue to hinder the economy’s recovery from the severe 2009 recession.

The government’s reform plans have only just started to address some of these structural challenges.

The negative outlook reflects the uncertain market environment and the risk of further deterioration in investor sentiment, which could constrain the country’s access to the public debt markets. If such risks were to materialize and the long-term availability of external sources of liquidity support remain uncertain, the country’s rating could fall further, Moody’s said.

Italy is a frequent debt issuer with refinancing needs of more than 200 billion euros ($267.12 billion) in 2012, Moody’s said.

Although future policy actions within the euro area could reduce investors’ concerns and stabilize funding markets, the opposite is also increasingly possible, the analysts said. Even if policy actions were to succeed in the short term in returning some degree of normality to euro area sovereign debt markets, the underlying fragility and loss of confidence is deep and likely to be sustained.

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