It had been a relatively quiet week for the euro with the much-anticipated ECB interest rate decision not sparking any fireworks. But like Cyclopip‘s gassy farts, credit rating agency Fitch dropped a bomb when everyone least expected it.
So what’s the story?
Well, Fitch downgraded Italy’s credit rating by one notch from AA- to A+. It cited the country’s high debt-to-GDP ratio and its gloomy economic outlook as a couple of reasons for the move. Italy also got minus points for political instability that could stand in the way of it fixing its balance sheets.
In response to the statement, the Italian government pointed out that there were good points in Fitch’s report too. It reiterated that reducing the debt-to-GDP ratio, which currently stands at 120% of its GDP, is possible. And also, Italy’s situation isn’t as bad as the other euro zone countries.
Now, let’s turn to what really caught the markets off guard – Fitch’s decision to downgrade Spain’s credit rating. Fitch has never been one to lead the pack, but among the major credit rating agencies, it was the first to address Spain’s situation.
But rather than lowering Spain’s long-term debt rating by just one notch, as we’ve been accustomed to seeing in recent downgrades, Fitch went the extra mile and reduced its rating by TWO NOTCHES from AA+ to AA-. The fact that this rating is a notch below S&P’s suggests that this may not be the last downgrade for Spain. After all, where one credit rating agency goes, the others usually follow. These guys love to play “follow the leader!”
According to Fitch, a cut is more than called for, especially since the growth prospects of Spain are anything but optimistic. With the European debt crisis still far from being resolved, the outlook for Spain has become even more blurry. As a matter of fact, forecasts for Spain are estimating growth of less than 2% through 2015.
Be that as it may, there are still those who think that Spain’s economic prospects are brighter than Italy’s. Having taken steps to address its fiscal problems earlier than Italy, Spain is believed to have already made a lot of progress in containing its national debt.
Still, we can’t deny that this series of downgrades spell more bad news for the euro, as it implies higher bond yields down the line. You have to wonder whether European officials will take all of this into account when they meet for the European Union summit next week. With two of their biggest economies on shaky ground, will they be forced to come up with an even bigger bailout plan?