(Recasts with more detail, new analyst comments)
By Emelia Sithole-Matarise
LONDON, Dec 8 (Reuters) - Italy’s borrowing costs rose slightly on Monday after its credit rating was cut nearly to junk though prospects of stimulus from Europe’s central bank tempered the increase.
Standard & Poor’s downgraded Italy’s rating to BBB- from BBB late on Friday, saying weak growth and poor competitiveness undermined the sustainability of its huge public debt.
For many in the market the decision highlighted the need for the European Central Bank to move ahead with sovereign bond purchases, or quantitative easing, which it has said it would consider next year, so the damage to Italy’s bonds was limited.
“The resilience (of) Italian bonds clearly shows underlying demand remains pretty firm and the market is putting more emphasis on what the ECB is going to do rather than what S&P said,” said Nick Stamenkovic, an interest rate strategist at RIA Capital Markets.
“Essentially the market is betting that the ECB will do sovereign QED early next year.”
The rating cut highlighted the anaemic and uneven pace of growth in the euro zone because S&P’s also raised Ireland’s rating to A from A-, rewarding the former bailout recipient for what it said was solid economic growth, improving employment and a debt reduction path that stands out in the euro zone.
ECB policymaker Ewald Nowotny emboldened those betting on QE, saying on Monday such a scheme could play a valuable role in addressing economic weakness.
As recently as June, Italy’s BBB rating had been affirmed. The downgrade is a setback for Renzi, who came into office in February promising an ambitious reform agenda to lift Italy out of recession but has seen the economy shrink further. A rating of BB or lower is considered junk and makes it harder for some investors to hold the debt.
Italian 10-year yields, a proxy for borrowing costs, rose as much as 8 basis points to 2.03 percent before retreating to trade at 1.96 percent, underperforming Ireland whose 10-year yields hit a record low.
Italy’s yields had also fallen to an all-time low, 1.915 percent, on Friday as the market focused on the possibility of further ECB policy easing. The S&P statement came after European markets had closed.
Some analysts, however, said Italy could face further downgrades once the decision on ECB QE is out of the way if growth fails to pick up and Renzi does not pursue more forceful reforms.
Renzi’s woes were exacerbated by calls on Saturday from German Chancellor Angela Merkel for France and Italy, the bloc’s second and third biggest economies, to enact additional measures ahead of a March ruling by the European Commission on whether their budgets conform with the bloc’s deficit and debt rules.
The comments in an interview with German daily Die Welt drew angry responses from Rome and Paris. [ID:nL6N0TR0IE}
Italian bonds also underperformed Spanish and Portuguese peers, whose yields were pinned near record lows.
Rabobank analysts said the S&P move underlined the underperformance against Spain.
“S&P’s downgrade likely simply validates the (yield) spread differential between Spain and Italy rather than provide any additional widening impetus,” Rabobank strategists said in a note.
“Going forward, with the ECB looking set to wade into the euro zone government debt market, playing an underperformance of Italy versus Spain looks set to be something of a pain trade.” (Editing by Anna Willard)