Moody cuts Italy's rating (Daily analysis 22.10.2018)

Cutting an Italian rating with limited impact on the euro. The German economy could have remained in stagnation in Q3. The zloty remains stable. EUR/PLN remains slightly below the 4.30 boundary.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

• A lack of macro data may noticeably impact the analyzed currency pairs.

Market expected worse results

On Friday evening, Moody's downgraded Italy's creditworthiness. It is now at the Baa3 level, one level above the speculative limit commonly referred to as junk. The agency has quite clearly pointed out Italy's weaknesses. First of all, it noted the clear deterioration of the country's fiscal prospects. Previously, it expected debt to GDP to fall from the second highest level in the eurozone. It is now expected to remain unchanged at around 130% of GDP over the next three years.

Moody's also does not believe in the Italian government's optimistic forecasts for GDP growth in the coming years and is more sceptical about the deficit in the next three years than Conte's administration. The agency also scores unproductive economic changes, i.e. guaranteed income, new ways to reach early retirement and the abandonment of VAT increases. The Agency also draws attention to the risks associated with higher financing costs for the Italian economy, which has already materialised in recent months.

Apart from the lowering of the rating, there is still a dispute between Rome and Brussels over fiscal issues. At midday, the European Commission received a reply from Italy on the Commission's earlier objections. Although the Finance Minister Tria is "aware that the budget plan is not in line with the Stability and Growth Pact", there is little chance that the deficit path will be clearly changed compared to the original plans of the populist coalition despite the EC's objections.

Yields on 10-year Treasury bonds are very variable as well. On Friday, they reached the 3.8% value, i.e. the highest since the beginning of 2014. Today they range between 3.30-3.50%. The market positively received the fact that Moody's decided to give it a neutral perspective despite the downgrade of the rating. Some economists feared that Moody's would suggest the possibility of cutting creditworthiness to junk with a negative outlook.

At the end of this week, S&P Global Ratings will also give a credit rating. A year ago, the agency raised Italy's rating. Now, due to the deterioration of the deficit path and negative changes to the potential growth, we can expect at least a negative perspective, and perhaps even a cut in the rating. Italy's subject is not going to disappear quickly and may still have a negative impact on the euro.

Bundesbank on German economy

It’s not only Italy that is generating negative information for the eurozone. Today Bundesbank wrote in a monthly report that the German economy may not have grown at all in Q3. According to Bundesbank, the stagnation could have been caused by the weak condition of the industry, which on average in July and August fell by 1.2% compared to Q2. This was mainly due to the very weak production of the automobile sector, which during the same period fell by 9% (mainly due to mandatory exhaust emission tests). According to Bundesbank, the condition of construction and assembly production, which dropped by 1.75% in August compared to July, also looks weak.

A consolation may be the fact that the German economy should return to a growth path, as Bundesbank assesses the current problems as being temporary. However, when data from Q3 (not only from Germany) start to flow in, worse results may encourage further economic divergence between the eurozone and the USA, which should harm the common currency and support the dollar.

Stable zloty

The zloty's situation is not changing much. EUR/PLN fluctuates close to 4.30. It seems that this level can currently be considered as a baseline. Some economists, on the other hand, fear that the result of local government elections may mean a more significant fiscal stimulus before next year's parliamentary elections.

For the time being, however, this risk does not seem to be crucial. Much more important is the external economic situation, the increase in fixed expenditures in recent years and the lack of structural reforms, e.g. the labour market. Poland's exports (goods) also look weaker, and the MPC's mild policy does not support the zloty. In the coming days, the zloty should be stable, and EUR/PLN will probably move close to the 4.30 boundary.