April 29, 2020 / 8:15 AM / a month ago

UPDATE 3-Italian bond yields rise after Fitch downgrade

(Adds German inflation data, updates prices)

By Yoruk Bahceli

LONDON, April 29 (Reuters) - Italian government bond yields rose on Wednesday but showed relatively little reaction to a downgrade of the country’s credit rating by Fitch, given that a further, immediate downgrade to junk territory appeared less likely.

In an off-schedule move, ratings agency Fitch cut Italy to BBB-minus on Tuesday, citing the impact of the coronavirus pandemic on the heavily indebted country’s economy. That means two out of Italy’s four credit ratings are now one notch above junk.

Since the coronavirus outbreak, markets have worried that the debt Italy will accumulate as it copes with the pandemic could lead to a loss of its investment-grade ratings, which would toss Italy out of the bond indices that many funds track, forcing managers to sell its debt.

Italy’s bond yields rose in early trade, with the two-year yield up as much as 12 basis points at one stage, but most of the losses were retraced by the close of trading. The 10-year yield rose as much as 10 bps to 1.83% and was last up 4 bps at 1.77%, far below one-month highs of nearly 2.30% hit last week.

The gap between Italian and German 10-year yields - effectively the risk premium Italy pays on its debt - widened to 225 bps, losing almost all its tightening since last Friday’s S&P ratings review, where Italy’s credit rating was held at BBB.

“In spite of the fact that there is a sell-off in Italian debt, it is not a momentous sell-off that we could have seen, should S&P have actually junked Italy last week,” said Rabobank strategist Matthew Cairns.

Fitch set the outlook for the rating at stable rather than negative, which analysts said makes a further downgrade into junk less likely.

Moody’s will review its rating for Italy - also one level above junk - next Friday. But it said last week that Italian creditworthiness should remain “broadly unaffected” given the temporary nature of the coronavirus crisis, leading analysts to see a Moody’s downgrade as unlikely.

That allowed for a relatively subdued reaction to the Fitch downgrade in Wednesday trading.

“Now that Fitch has downgraded them and Moody’s and S&P have ruled themselves out... we actually think that Italy is going to be investment-grade for another six months,” said ING senior rates strategist Antoine Bouvet.

Taking into account the unlikelihood of forced selling due to a loss of investment-grade ratings as well as support from ECB emergency bond purchases, Bouvet said it would be too early for investors to forego the gains they can make on Italian debt.

Rabobank’s Cairns said sentiment was helped by the fact that Fitch said its rating committee changed its decision after an appeal from Italy that provided additional information.

Italy sold nearly 6 billion euros over three bonds in an auction, where its 10-year debt costs touched a 10-month high

In higher-rated markets, Germany’s 10-year benchmark yield fell 4 bps to -0.50%, the lowest in more than a week , before closing at -0.49%.

German annual inflation slowed further in April to 0.8%, well below the European Central Bank’s target, data showed on Wednesday.

Elsewhere, euro zone lending surged to a decade-high in March as firms rushed for emergency funding with the region’s economies remaining in lockdown. (Reporting by Yoruk Bahceli; Editing by Mark Heinrich and Alex Richardson)

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