Three-notch reduction came hours after George Osborne and Brussels called on Europe's leaders to prop up bank finances
Italy suffered a bruising downgrade by ratings agency Moody's on Tuesday night in move that is expected to intensify pressure on European leaders to shore up the eurozone's banks in a bid to resolve the sovereign debt crisis.
Just hours after chancellor George Osborne and officials in Brussels were united in calling on eurozone leaders to bolster the financial strength of their banks, Moody's delivered a huge three-notch downgrade on Italy's debt ? its first downgrade of Italy since May 1993.
The agency, catching up with a downgrade by Standard & Poor's in September, blamed "the fragile market sentiment" that could push up the country's financing costs.
"Although future policy actions within the euro area could reduce investors' concerns and stabilise funding markets, the opposite is also increasingly possible," Moody's said.
The move came at the end of a day when markets were awash with fears that ?3.4bn (�2.9bn) of exposure to Greek debt would bring down Franco-Belgian bank Dexia and tensions rose across the banking sector, putting pressure on the European Central Bank to be more generous in loans to banks to prevent a rerun of the 2007 credit crunch.
The gloom that has lingered over the banking industry since August deepened further when Deutsche Bank, Germany's biggest, warned it would miss its profits target and the cost of insuring major US banks against default reached levels last hit in October 2008.
Osborne and Anders Borg, the Swedish finance minister, had been urguing colleagues at their meeting in Luxembourg to prop up banks, possibly with public funds, even before the downgrade of Italy and despite fierce resistance from the French, who insist Europe is not at risk.
Senior officials led by Olli Rehn, EU economic and monetary affairs commissioner, backed the stance of Osborne and Borg, which is endorsed by Christine Lagarde, managing director of the International Monetary Fund. She has said up to ?300bn in capital may be required.
Comments by Rehn, reported after European markets had closed, that there was now a "shared view" of the need for co-ordinated action in banks helped to lift Wall Street off its lows to end the day higher.
But the Italian downgrade landed after US stocks stopped trading and Italy's prime minister Silvio Berlusconi tried to play down its significance, saying "Moody's choice was expected". Moody's cut Italy to A2 with a negative outlook.
"The Italian government is working with the maximum commitment to achieve its budget objectives," Berlusconi said.
The downgrade may nevertheless put more pressure on Italy's banks at a time when the need to shore up confidence in the eurozone's banks is increasingly recognised by politicians. Senior figures are pressing for stress tests for Europe's banks to be brought forward from next year after Dexia passed the July tests with flying colours. Several officials in Luxembourg referred to Dexia as "the canary in the coalmine".
Osborne is among those leading the calls for eurozone banks to be strengthened, amid fears about the impact on the UK if the eurozone crisis is not contained.
"We need to reflect the reality of the situation in the euro area and account for the reality of the sovereign risk the market can see out there and that requires more capital in some eurozone banks," Osborne said. Fresh capital would preferably be raised privately, he said, but a public backstop might be necessary.
Borg, also a non-zone minister, was blunter. "Government support is the best kind of backstop," he said.
Rehn appeared to be endorsing their view, saying: "We need to get more firepower against contagion effects and support recapitalisation of the banks."
The head of the European regulator, the European Banking Authority, Andrea Enria, joined the chorus of calls to solve the eurozone crisis. "It's a major issue that could go from Dexia to other banks, so it's important this is fixed and the sooner it's done the better," said Enria, who oversaw the July stress tests on banks.
Bob Diamond, the Barclays chief executive, speaking at a London conference, called on European leaders to be decisive. "Confidence will not be restored until the EU sovereign debt issue is resolved. This is the most critical issue weighing on the markets right now," he said in a call for greater fiscal union in Europe.
Investors are urging leaders to restore confidence in the banking sector. Robert Talbut, chief investment officer at Royal London Asset Management, said: "The stress tests have once again been shown to have come up short in terms of what investors were looking for. Banks need a forced recapitalisation. It is exactly the right thing to do to rebuild confidence." He said banks should ideally be split into "bad" and "good" and warned a eurozone shock would threaten UK banks. "If Europe falls over, at least two of the UK's banks and possibly three will need recapitalisation."
A rare spot of upbeat news came from UBS, the Swiss bank hit by the alleged $2.3bn rogue trading scandal, which said it now expected to make a "modest" profit in the third quarter, having previously warned of a loss. Analysts noted that the reason for the change was the falling price of UBS debt, which, under an accounting quirk, helps to bolster its profits.
Deutsche Bank warned of 500 job cuts and admitted it would not reach its ?10bn profit target this year. Its shares fell 4% as it was forced to take a ?250m writedown.
Pressure is also being felt on banks in the US. Gavan Nolan, director of credit research at Markit, noted that the cost of insuring Morgan Stanley and Goldman Sachs hit levels last experienced during the October 2008 crisis.
In a sign of the pressures facing US banks, Bank of America ? which absorbed Countrywide and Merrill Lynch during the October 2008 crisis ? announced it was shutting down one of its mortgage units after failing to find a buyer.
While the markets await a potential capital injection for the eurozone banks, top bankers are hoping the ECB will soon decide to extend credit to eurozone banks from three months to a year, or even two, in an effort to calm tensions.
Source: http://www.guardian.co.uk/world/2011/oct/04/italy-downgrade-moodys-increases-pressure
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