April 27, 2020 / 8:05 AM / a month ago

UPDATE 3-Italian government bond yields fall on ratings relief

(Adds latest prices)

By Abhinav Ramnarayan

LONDON, April 27 (Reuters) - The Italian government’s borrowing costs dropped on Monday three days after S&P Global left the country’s credit rating unchanged, calming worries about a potential junk rating for the euro zone’s third largest economy.

Many analysts expect Italy’s already-high debt to soar to around 150% of gross domestic product as it grapples with the economic damage caused by the coronavirus.

Concerns were mounting that Italy will also lose its investment-grade status along the way, potentially pushing its bond yields far higher.

But S&P Global on Friday affirmed Italy’s credit rating at ‘BBB/A-2’ - two notches above junk - saying the country’s diversified and wealthy economy and net external creditor position partly offset a drag from high public leverage.

“It diminishes the risk of investors dashing out of Italian bonds in case of a downgrade into junk, particularly as the next potential reviews are three or six months down the line,” said ING rates strategist Antoine Bouvet.

But he added that in the longer term, it is hard to see how Italy can keep its current rating level as debt rises.

“They are very much dependent on ECB rates remaining low for the foreseeable future,” he said.

Italy’s benchmark 10-year bond yield was 12 basis points lower at 1.77% on the first day of trading after the decision, while the spread over German 10-year bond yields dropped to its tightest level in more than a week, at 216 bps.,

German 10-year bond yields, the benchmark for the region, rose 2 basis points to -0.447% as more confident investors bought into riskier assets.

Short-dated Italian debt yields also fell, with two-year yields down 16 basis points at 0.71%.

Other Southern European bonds also benefited from the relief over Italy. Spanish and Portuguese 10-year yields dropped around six basis points each.,

That said, market gauges are starting to reflect the risk that another existential crisis may be building for the euro zone. That puts pressure on the European Central Bank to keep stimulus flowing and debt-financing costs within sustainable levels.

The central bank is due to meet later this week, and market participants will be watching for any indication on what more it will do to help the euro zone economy through the coronavirus crisis.

Reporting by Abhinav Ramnarayan Additional reporting by Tommy Reggiori Wilkes Editing by Larry King and Giles Elgood

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